How would you handle an unexpected bill of $1,000?
A recent survey from Bankrate found that only 39% of Americans could cover the cost from savings. Eighteen percent would pare down spending in other areas to pay the bill. And 4 in 10 adults would go into debt as a result.
But, given the choice, most people would vastly prefer to have cash on hand instead of being strongarmed into debt or a barebones lifestyle.
That’s precisely where an emergency fund comes in.
If you’re just getting started with building an emergency fund, you probably have a lot of questions about what it is and how it works.
An emergency fund is a reserve of money that you access only in cases of financial emergency. With a healthy emergency fund in place, you have immediate access to cash when a crisis hits.
As a result, you’re not forced to use credit when you would have preferred to use cash. So, with the money on hand, you can handle an urgent situation without the added stress of being short on cash. And the impact of that problem won’t translate to months (or years) of interest payments on debt you never wanted to incur.
So, what constitutes an “emergency” anyway? It’s an urgent financial need that’s not foreseeable:
Use your emergency fund to cover your rent, food, and utilities if you suddenly lose your job.
Tap those savings when you’ve got medical bills after an unexpected hospital visit.
Access the cash when your car breaks down or your furnace dies mid-winter.
But leave your emergency fund alone for other types of expenses:
Budget separately for your regular monthly bills.
Use a sinking fund to save in advance for known costs that are coming down the road — a semi-annual insurance payment, holiday gifts, or that driveway repair you’ll need next year.
Don’t withdraw from your emergency fund for luxury items. Save separately for your “wants” and keep your emergency fund ready in case you can’t pay for your “needs” someday.
Once you’re ready to start building your emergency fund, where do you keep that money? You’ll want to follow these four essential rules:
1. Your emergency fund should be accessible.
Don’t lock up your cash in a Certificate of Deposit (CD). A CD holds your money hostage until the term expires or charges you a penalty for early withdrawal.
Likewise, don’t invest your emergency fund in stocks, real estate, or any other assets. You want to get your cash immediately without waiting for those assets to sell.
2. Your emergency fund should be somewhere safe.
You want it somewhere physically safe for sure — not tucked under a mattress or kept in a box at your home.
But you also want your emergency fund to be financially safe. So, the cash should be insured and preserve its value. Keep your emergency savings out of the stock market, where its value can shift over time.
3. Your emergency fund should cost nothing to withdraw.
You definitely don’t want to pay for the privilege of accessing your own savings.
Ensure your emergency fund isn’t held in a financial account that charges early withdrawal fees or penalizes you for unauthorized use. So don’t put emergency savings into a CD, IRA, 401(k) plan, Health Savings Account (HSA), or 529 college savings plan.
4. Your emergency fund should be separate from all other cash.
Don’t complicate your finances by dumping all your money in a single account. You want to know what cash is there for upcoming bills, what’s reserved for emergencies, and what’s yours to spend on the fun stuff. You might consider setting up simple, separate savings accounts.
What’s the best place to save your emergency fund?
Look for a high-interest, FDIC-insured savings account. Open one through a bank or credit union. It takes just minutes to set it up and start saving!
That’s a wide range! Ask yourself these questions to pin down your emergency fund target:
What would your expenses be if you or your partner lost a job? Keep in mind that you’d likely cut or reduce unnecessary costs after a job loss.
How long would it take to replace your income after losing your job? Be realistic about your timeframe. And remember: In the meantime, you might be able to secure part-time or lower-paying work that would replace part of your former income.
How much emergency savings would make you feel safe? Your emergency fund is there to protect you financially and give you peace of mind. If an extra cushion gives you that added feeling of security, adjust your target accordingly.
Once you calculate your target savings for your emergency fund, you might just do a double-take. At the end of the day, most people should have emergency funds with several thousand dollars saved up!
A target that size can be overwhelming. Building your emergency fund does take time — sometimes months or even years. But you can stay on track and even accelerate your journey with a few simple strategies:
1. Pay yourself first.
List your contributions to your emergency fund in your budget as an expense — just like any other bill.
Resolve to save a fixed amount every single month. Maybe that’s $50, maybe $200 — whatever you can reasonably save.
2. Keep it consistent with automation.
Over time, it’s easy to forget about your emergency savings goal. So let technology handle it on your behalf. Set up automatic bank transfers that move the money once a month (or every payday) from your regular account to your emergency fund.
3. Get there faster with bonus contributions.
When extra money comes your way, consider putting some or all of it directly into your emergency fund. For you, extra cash may take the form of a tax refund, workplace bonus, birthday gift, or inheritance.
If you save your extra cash along with your regular monthly contributions, you’ll reach your emergency fund savings goal that much faster!
A healthy emergency fund is essential to your family’s financial health. With savings in reserve, you can face a crisis without the added stress of money worries. And you can keep your family afloat without turning to unwanted, expensive debt.
So, start building that emergency fund today! And enjoy the peace of mind that comes from knowing you’re protecting yourself and your loved ones.