Financial planning can’t prepare you for all of life’s unpredictable curveballs. Whether it’s a sudden illness, a critical car repair, or other unexpected expenses, those bad things happen to the best of us, and they can throw a serious wrench in your life. That’s why having an emergency fund set aside can make a world of difference if life takes a sudden turn for the worse. Read on to learn how to build an emergency fund!
An emergency fund can cover a multitude of unforeseen events for you and your family. This article will provide you with helpful tips on how to build emergency savings.
What Is an Emergency Fund?
An emergency fund is an amount of money set aside to cover the unexpected that helps you fill in the financial holes that unforeseen circumstances have created. When disaster strikes, the fund is like your guardian angel, there to help you pick up the pieces.
An emergency fund can prevent you from going into debt during a crisis. Savings can create solutions to problems usually solved by creating more debt with credit cards and personal loans. Ideally, your fund will cover you so you won’t have to go into debt or sell off investments or other assets. If you are in a financial emergency, adding to the list of people you owe will only push back any timeline you set for getting out of debt.
None of your other bank accounts must connect to your emergency savings. The fund is insurance for when you experience an emergency or disaster. As such, it should be a fund that you don’t touch until you need it. While your emergency funds should be accessible, separate them from any money that would be considered available funds.
Emergency Savings: How Much Should You Set Aside?
Most financial experts recommend creating emergency savings that cover three to six months’ worth of expenses. But of course, the amount varies from person to person. People who may have dependents (like children), underlying medical conditions, or other variables in their life may need to plan to save more. Some people may need to fund an emergency for 12 months or more.
If you think that a year’s worth of expenses is a lot to save, don’t worry—you’re right.
This amount of money may take a lot of time to save, so think of this number as more of a goal to keep your commitment to building up this vital reserve steadily. Once you’ve achieved your emergency savings goal, you may want to consider putting your savings to work for you by putting it in an interest-bearing account or reducing your contribution and put some money towards paying off debt. Regardless of what you choose, you can rest assured that your hard work will pay off in the long run.
How To Start Building an Emergency Fund
Getting your emergency fund is going to take some effort. Just like any other financial plan, it’s going to take a little planning and a whole lot of discipline. Here are some tips on how to start practicing this essential financial habit:
Pay Yourself First
Your next emergency can come at any time. Being prepared for the unexpected is as important as all the other essentials of your life. So, make room in your budget for a contribution to your emergency savings. Your donation doesn’t have to be significant at first. It just needs to be consistent.
Set Automatic Tranfers
If your employer offers direct deposit, You can send a portion of your paycheck directly to your emergency fund account. That way, you don’t have to take on the responsibility of depositing your contribution yourself. This tactic increases the odds that you won’t use your funds for something other than a real emergency.
Stash the Windfalls
Did you get an extra envelope of cash for your birthday? Maybe you finally won your monthly poker game? Put that unexpected money away for unplanned expenses. It’s always great to stumble upon some extra income. And a good move is to stash at least some of it for that inevitable rainy day.
If you get a tax refund, direct it into an emergency fund. You can also adjust your W-4 tax form so that you have less money withheld. You can then put the money that would have been withheld into your emergency fund.
Make Budget Cuts
Okay. This is the tough part of your emergency fund building. Your financial plan’s success depends on how you deal with this fact—to save more; you have to spend less.
You could ride a bike, skateboard, or scooter to save on gas. You can cook your food to save on the cost of buying lunch from a restaurant. You can download a free book from a library instead of buying a book. Calculate how much you are saving each month from these daily changes, and put it in your emergency fund.
The fastest way to build your emergency fund is by making big contributions, so wherever you can make cuts, do it. You can consider relaxing some of that discipline when you reach your emergency fund goal (or even a savings milestone). The more you save, the better off you will be.
Increase Your Contributions Over Time
Don’t forget to re-evaluate your plan every six months to see how much you’re saving. It’s essential to tweak the amount of money you take out if you recently withdrew from your emergency fund and keep an eye on how much money you’re saving to make sure you don’t run out. And again, consider the funds you’ve saved if you’ve saved up enough and have extra cash!
Appreciate your victories. If you’re sticking with your savings habit, don’t miss the opportunity to celebrate your successful decisions. Find a few ways to congratulate yourself, and if you’ve reached your goal, set your next one.
Where Do I Keep My Emergency Fund?
Where you keep your savings for unplanned expenses is critical. Ideally, money should be kept in a place where it can grow without being touched for anything outside of an actual emergency. The best options vary, depending on your level of access to them and the return on your deposit. Let’s take a look at a few.
If you want to have immediate access to your emergency fund at a moment’s notice, then a traditional checking or savings account may be for you. With an average annual percentage yield (APY) of 0.06%, a standard savings account will give your money the slightest opportunity for growth (outside of keeping it in a shoebox under your bed, of course). Keeping your emergency savings in a regular bank account can also create some unneeded temptation to spend. When your money is available, you are more likely to spend it on things that aren’t emergencies.
An excellent way to manage that separation is to keep your emergency savings in a different bank or credit union than the one you use for your other accounts. You may be able to arrange an automatic deposit every payday so that you can put money in your fund directly from your paycheck. Separating your emergency fund in this manner keeps it out of your immediate view, which increases the likelihood that it will remain untouched (and therefore plentiful) when you need it.
High-Yield Savings Account
Growing your emergency fund in a high-yield savings account allows your money to grow while readily available to spend. High-yield savings accounts tend to require a minimum deposit to keep them open. Also, this kind of account rarely allows any super quick access to cash without a prior credit check. Unlike a standard account that you can access through an ATM or a brick-and-mortar bank branch, money moves through a series of electronic transfers. Many online banks offer high-yield savings accounts with an APY that is ten times the rate of a standard savings account. These savings accounts can be very competitive, so be sure to shop around for the best rate.
Money Market Account
A money market account is another interest-bearing account at a bank or credit union that pays a higher interest rate than a traditional savings account. These accounts earn money by investing funds in government securities. A standard savings account is only allowed to earn interest. Unlike a high-yield savings account, a money market account can be accessed with a debit card or include check-writing privileges. These features make a money market account an excellent place to hold your emergency funds and keep them liquid and readily available when you need them the most. A money market account is ideal for short-term goals like saving up for a vacation or a wedding.
Certificate of Deposit (CD)
Certificates of deposit (CDs) can grow an emergency fund quickly but with restrictions. This savings option requires you to hold your money in an account for a specific, non-negotiable amount of time. However, at the end of the term (maturity), the rate of return on your deposit is guaranteed. A high-interest rate will increase your emergency savings, your access to your money is extremely limited. And if you do withdraw your money before your CD fully matures, you will pay a penalty fee. CDs can come with varying rates of return—which are higher than any bank account and most money market accounts. But, when considering a CD, know that you’re essentially betting on not needing your emergency savings for a while.
The simple fact is that emergencies can always happen, and you need to be prepared for them.
Even though it makes sense to build an emergency fund, many people do not consider it a priority. Many people living paycheck to paycheck believe that they don’t have the means to set aside emergency funds for unexpected expenses, and it’s something that can wait until they have money to save. However, working even a small contribution to an emergency fund will help this become a financial habit. You can build good financial habits with even a little effort in the beginning. As your income grows, so can your contribution. With effort, you will master the practice. And building an emergency fund is one of those habits that can’t afford to wait. When you see start to see that emergency fund rise, so will your peace of mind.