Finance 101

What is an emergency fund?

July 5, 2023

We can’t predict emergencies, but we can try to plan for them.

That’s the concept behind an emergency fund, which is a separate account set aside for unpredicted expenses.

An emergency fund acts like a cushion or buffer for your finances. The money allows you to weather a storm financially without going into debt or even bankruptcy as a result.

In this article, we’ll look at why you need an emergency fund, how you can build an emergency fund, and where you should put the money.

Why do you need an emergency fund?

Emergency funds are intended to pay for the big stuff in case of – you guessed it – emergencies. For example, you have to pay a medical bill to get care. Your car breaks down and needs a major repair or you can’t get to work. Or you get laid off and your family needs money to survive until you find new employment or unemployment checks begin.

Your emergency fund should not be used to pay for non-emergencies, like discretionary spending (on things you don’t need) or when you want something your budget doesn’t cover. suggests only using your emergency fund only when the situation meets these two criteria:

  • your life or health is majorly disrupted if you don’t pay the money
  • you must pay for it immediately

And while it’s obvious, it’s worth saying: the only way to maintain an emergency fund is to put the money in and leave it alone except in case of emergency. To be successful you must think of your emergency fund as un-spendable unless your life or livelihood (job/income) is affected.

How much should you save for an emergency fund?

There is no one right amount to save for an emergency fund. How much you need depends on a lot of factors unique to you. Consider whether you are paid regularly, how many people you support, how old you are, and even your health status. If you know an emergency is possible, prepare as much as you can. Consider these questions as you set your savings goals:

How much emergency fund should I have? A good rule is to save at least $500 so you could cover an important bill. Then continue to save and work your way up from there, first to 3 months of living expenses. Most experts recommend 6 to 8 months’ living expenses or salary as the goal for emergency fund savings. Some suggest more if you have a family to support or you have inconsistent income, like with contract work.

How long does it take to build an emergency fund? This will depend on how much money you’re able to set aside each month. If you’re living paycheck to paycheck, start with the amount you think you can do without, no matter how small, like 1% or 2%. Then keep going, consistently saving that amount each paycheck. If you don’t touch the money, it will add up over time. And the more money you save, the faster it grows.

Where to keep your emergency fund?

The most important consideration with where to save your emergency fund is this: you have to be able to get to the money quickly if an emergency comes up. You don’t want to save the funds in a long-term investment, for example.

Most experts recommend a high-yield savings account separate from your regular bank account. This will ensure you don’t dip into your emergency fund and makes it easier to keep it untouched. This type of account also gives you instant access, lets you earn money on your savings, and is federally insured.

Money market investment accounts and certificates of deposit (CDs) may also be good places to save emergency funds. With these accounts it may take a bit longer to access your money. Take a look at the options available to you, and make sure at least some emergency money can be accessed immediately, like with a savings account.

If you have low credit or closures/issues on your credit report, you may not be eligible immediately for a high-yield savings account. If this is the case, do the work to resolve any issues on your credit report. And in the meantime, look for a “second chance” checking account. These accounts are designed to help people rebuild their credit. It may only take a few months to build a good banking record with a second-chance account before you become eligible for a higher-interest account.

The higher the interest rate you can get, the more money your savings earns for you while it sits in the account.

How do you build an emergency fund?

If you’ve been wondering how to build an emergency fund, you’re not alone. “How can you build an emergency fund” is a very common internet search.

Here are some ideas for building an emergency fund:

  • Get started today. Start as soon as possible. This helps you prepare for emergencies. It can also help you prepare for later in life. The longer you have to save money, the more it will grow.
  • Save some of your pay from each paycheck automatically. Choose a percentage to save, then ask your employer to automatically transfer that amount from your paycheck into savings. When you don’t even see the money in your account, it’s much easier to leave it alone.
  • Save your tax refund. It’s tempting to spend it on fun things, but saving your tax refund each year is an amazing way to build your financial cushion.
  • Check if your employer has an emergency saving program. Some employers have introduced plans encouraging their employees to save. Some have a financial education requirement; others even offer to match part of what you save.
  • Keep the change. Some savings apps and accounts let you round up when you make a purchase, sending the extra amount directly to a savings account. The idea is that you won’t miss the small amounts – but they can really add up.
  • Adjust when you can. After a few months of saving, you may realize you could contribute a little more to your savings. If you get a raise, you may want to bump up your savings also.

It’s easy to get motivated when you see your emergency account growing. That’s because your emergency fund represents financial safety – and the door to a better future.

FAQs: What is an emergency fund?

Should an emergency fund be all cash?

No. Cash isn’t insured. It’s best to keep emergency funds in an insured account, like a savings account at a bank. You can still get to the money quickly in an emergency. You may even have immediate access with online banking access.

What is the difference between savings and emergency fund?

Saving is keeping money for a goal. You could have a regular savings account to set aside money for lots of reasons – a family vacation, a bike you want, predicted home repairs, or a new TV. An emergency fund is like savings, but you don’t touch it, and it’s only for true emergencies. It’s only used if there’s a situation that disrupts your life or health and money has to be paid immediately to correct it.

Can insurance help protect me in an emergency?

Insurance is important, and can protect you from certain types of losses. But it takes time to get money from insurance. You might have immediate needs, like eating or getting medical care.  That’s where your emergency fund comes in. Keep in mind that most insurance companies also require you to pay a deductible on a claim, often of $500 or more.

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