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What is an emergency fund?
An emergency fund is a safety net of money that is easy to access in case of an urgent financial situation. Having an emergency fund is a core part of being financially healthy, so that you can help protect yourself from natural financial ups and downs.
Why is it important to have an emergency fund?
An emergency fund is an important fund to have in your back pocket. It means that you will be more prepared for a sudden expense and that you can handle small financial hits more smoothly. Unemployment, illness, and family emergencies can come up with no warning, and having an emergency fund can help ease those stressful situations.
How much money should you have in an emergency fund?
Now that you know what an emergency fund is, you might be wondering how much you should save. People have different estimates about the best amount to save in an emergency fund, and the answer will depend on your income and spending habits.
Generally, your emergency fund should have somewhere between 3 and 6 months of living expenses. That doesn’t mean 3 to 6 months of your salary, but how much it would cost you to get by for that length of time. Include expenses like rent, utilities, debts, and food, and don’t take into account non-essential luxuries that you'll be able to eliminate if needed, such as entertainment and dining out.
Some other questions you may want to ask yourself are:
- Is my career path or industry particularly risky?
- Do I reliably make the same amount of money every month?
- Could there be times when I make less than I do right now?
- Have I budgeted for my whole family? How will my family’s financial needs change down the road?
If you don’t think you can hit the recommended target of 3 to 6 months of savings, remember that something is better than nothing. Start saving in small amounts every month, and soon you’ll have a nice cushion.
Building an emergency fund
Step 1: Set a goal
Now that you know how much you should have in your emergency fund, you can set your own goal. Stay realistic and remember that an emergency fund should at least cover rent or housing, utilities, debts, and food for three months.
Step 2: Decide on a budget
Saving for an emergency fund doesn’t need to be painful. Look at your current income and spending, and see where you could cut back even a dollar a day. The more you can cut from your expenses, the faster you can save!
Step 3: Set up automatic transfers
Setting up automatic transfers can help take the hard work of saving out of your hands. Look for a savings account with a feature that lets you set up daily, weekly or monthly deposits from your checking account to your savings account. Some banks provide options for automatic transfers that let you set specific goals and track your progress against them. Once you’ve built up your safety net, you can start saving for your next goal, like a vacation or college fund.
Where should you keep your money?
The point of an emergency fund is that it should be easy to access. That means long-term accounts such as CDs may not be a good fit. An FDIC-insured savings account is a great place to keep emergency funds but be sure to do your research and pick an account that suits your needs.
When should you use your emergency savings?
A financial emergency is an event that causes an unforeseen expense, like a car repair or a medical bill. Reserve your emergency fund for these situations and don’t hesitate to use it when you need it – that’s what it’s there for! The key to building a reliable emergency fund is to continue replenishing it after you use it during downtimes.
Ideally, expenses such as taxes and home repairs shouldn’t come out of your emergency fund. You should set up a budget that has room for costs you can foresee. However, using your emergency fund is a better alternative in these scenarios than taking on debt.
What to do after you’ve built an emergency fund
After you’ve reached your savings goal for your emergency fund, you don’t need to keep adding to it forever! Your emergency fund should be in a place that’s easy to access and secure, like a savings account. However, those accounts don’t tend to have the best return on your money. Once you have a great safety net, you can focus on other savings goals, like your next vacation or a new house.