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Emergency Fund | Why It Matters and How to Build One
Unexpected situations can turn your finances upside down, but it doesn’t have to be that way. An emergency fund is your insurance against spontaneous financial setbacks that could otherwise be budget busters.
So, when it comes to stuffing your piggy bank, exactly how much do you need to stash away? There’s no way to know the cost of an unforeseen circumstance, but there are a few general recommendations to follow.
Here, we’ll explain the importance of an emergency fund, how it works, and how to set up this vital resource.
What is an Emergency Fund?
An emergency fund is the money you set aside for unpredictable expenses. If you think you are ready for such emergencies, consider what might happen if you experienced any of these:
- Layoff or Termination – Losing your job for any reason can mean weeks or months without income. An emergency fund gives you time for a job search. It allows you to cover your expenses while you wait for unemployment benefits.
- Natural Disaster – Fires or flooding strikes rarely, but they do happen. Insurance covers a lot, but the fine print in that policy may leave you with uncovered expenses.
- Accident, Illness, Disability – Even with medical coverage, you are bound to have out-of-pocket costs. There are conditions that policies only cover partially, and elective operations can big of a strain on your finances.
- Car Breakdown – You can’t always count on that warranty to cover everything. And what if you have to rent a car for a few weeks while your vehicle is in the shop?
How Much Money Should You Save in Your Emergency Fund?
Financial experts have determined that an emergency fund should be enough to cover your expenses for three to six months. So, take your monthly expenses, multiply that figure by 3, and that’s a starting goal for your emergency fund.
Other variables in figuring out how much to put in an emergency fund include the size of your budget and what you can afford to set aside regularly.
Many people say the bigger, the better. That’s because it’s impossible to predict what might happen and how much it will cost. A sudden shock to your bank account may set you back for just a short time. But things like a layoff or a home repair that moves you out of your house for weeks can run into big money.
How to Build an Emergency Fund?
Stashing that extra money away is critical since saving is the best way to reach your goal. Here’s how to do that:
- Have a budget – Bankruptcy courts are full of people who never kept a budget or simply ignored expenses. So, calculating a monthly budget of expenses that includes everything is a good start.
- Set your goal – Three to six months’ worth of expenses is a good rule of thumb, but you can start with less. You want to contribute gradually, and you needn’t shift from your other investments if you can save.
- Figure how much you can set aside – Every budget has a little to trim. Maybe you don’t eat out as much or miss a concert or show. Those entertainment or miscellaneous expenses are often a good source of savings. After you’ve found budget savings, you can start emergency fund savings. You have a start if you set aside as little as $20 a month.
- Jumpstart your fund – Banks sometimes offer incentives for opening a new account. Check them out and take advantage because you may get a nice bonus for opening an account.
- Save with your salary – Most people these days are paid through direct deposit to a bank account. But you can automatically divert some of that money to an alternate account, such as your emergency fund. If you get a paper check, use a small part of it for your fund.
- Contribute more – If you have had a good month, a raise, a windfall like a tax refund, or you have paid off a long-term loan, you have more money for your fund.
- Don’t stop saving – Once you reach your goal, don’t stop saving. Six months of expenses is a good goal, but an outright catastrophe may require even more. Your yearly expenses would be the next target.
Where to Keep Your Emergency Fund?
A high-yield savings account is the best place for that money you set aside. It carries enough interest to offset inflation, is accessible anytime, and is federally insured. Try shopping online-only banks, which often have higher yields and lower fees.
A money market account could be another home for your emergency fund. You can find a higher yield there and often get check-writing or debit card privileges. But the interest rate is not fixed and may fluctuate with market conditions. And you may run into penalties if the account runs low.
Where Not to Put Your Emergency Money
Certificates of deposit (CDs) often offer even better yields. But CDs are issued for a fixed time, and you can only redeem them at the end of a term. In an emergency, you may be unable to wait for that money to come free.
When to Use Your Emergency Fund?
Use your emergency fund whenever an expense arises that your budget cannot absorb. If you have a budget line that says “miscellaneous,” and your unexpected expense exceeds that, you know you are cutting into food, clothing, rent, and other basic necessities to cover the cost.
Emergency Fund Spending Example
Let’s say your home heating/air conditioning breaks down — the bill: $2,500. You run a budget of $4,000 a month, so a $2,500 expense is unworkable, and heating and air can’t wait.
Things like that HVAC bill proves the worth of an emergency fund. So keep up the saving, because you never know.
Saving Isn’t Just for a Rainy Day
Budgeting and saving are sound financial practices for anyone. They are of utmost importance when building an emergency fund that you will certainly need at some point. Most importantly, when you use the fund, replenish it as soon as possible.
StockMarketEye can help you monitor your emergency fund and the entirety of your financial plan for the future. You can keep up with your savings, retirement, and investments with our easy-to-use software. So, save for emergencies and explore the financial tools in SME with our free trial. On both counts, you’ll be glad you did.