Emergency Fund Guide: How Much and How to Build One
If 2020 has taught us anything, it’s the importance of an emergency fund (and regularly washing our hands). While you may be able to take out a loan or use a credit card in a pinch, cash savings let you cover necessary expenses without taking on the extra burden of interest.
What Is an Emergency Fund?
An emergency fund is money that you set aside and can easily access during an emergency crisis. Whether you’re caring for yourself, your family, or a loved one, you can use this money as your first line of defense after a medical emergency, a lost job, cut hours, or another unexpected crisis event impacts affects your finances.
Unlike retirement funds, the goal isn’t to invest and greatly increase the value of your emergency fund money from investment returns over a long period of time. Generally, you want to keep your emergency fund in a secure account, such as a savings account that won’t drop in value based on changes in the stock market.
Set Your Goal: Figuring Out How Much to Save
Building your savings may take time. You’ll have to look for ways to cut costs, increase your income, and determine the right emergency fund amount for your household.
The general guidance is to build up at least three to six months’ worth of your necessary expenses—which means you’ll first need to figure out how much that is.
You can start by listing your fixed and variable expenses. If you haven’t been tracking them, you can use a budgeting app such as Simplifi by Quicken to link your bank and credit card accounts including:
- Fixed expenses: Rent or mortgage payments, loans, credit cards, insurance, telecoms (TV, phone, internet), child care, and tuition.
- Necessary variable expenses: Food, utilities, transportation, personal care, clothing, and gifts
- Infrequent expenses: Vehicle registration, non-monthly insurance payments, and annual subscriptions
Strictly speaking, some expenses might not be “necessary,” but be realistic about what you’ll need during an emergency. An occasional treat can help keep your spirits high, and having a little money for those expenses can be important as well.
After you’ve filled out your list, add up all the monthly expenses and multiply the result by three and six. Aim to build up an emergency fund amount within that range, and add your emergency fund as a goal in your budgeting app to track your progress.
Rather than viewing contributions as something you do after everything else, consider your emergency fund as part of your fixed or necessary variable expenses. While it might not feel like a necessity today, you will be using the money for your essential expenses during an emergency.
Saving Your First $1,000
You’ll likely have an emergency fund goal of thousands of dollars, which can feel completely out of reach. But you can start small.
Rather than going from zero to 10,000, set a more modest goal of $500 or $1,000. It’s enough money to help you get through common setbacks, such as a car repair but won’t feel as daunting as the full amount.
After you settle on your goal, you’ll also need to figure out where the money will come from. Again, turning to your budgeting app and record of past transactions can help.
Look for discretionary (i.e., non-necessary) spending where you can cut back and ways to save money on your necessary expenses. You may be able to find a cheaper insurance policy, refinance debt to save on interest, or find other options that free up money without changing your day-to-day life.
Making extra money can sometimes be easier and faster than cutting back. Whether you can take on extra hours or find a new contract job, a temporary extra push can help you reach your goal.
Building Your Full Emergency Fund
It can take time, persistence, and a little bit of good fortune to slowly save up your entire emergency fund amount. And an emergency in the midst of your building phase can drain your fund and force you to start again. Although that can be frustrating, it also serves as a reminder as to why setting aside the money is so important in the first place.
Some people find ways to speed up the process by changing their lifestyles to greatly decrease their expenses or increase their income.
Forgoing dining out, moving into a smaller home, negotiating a raise, or getting a higher-paying job (perhaps after a bootcamp or immersive program) can be game-changers. These same practices can also help you pay down debts or accumulate wealth beyond your fund.
Where to Keep Your Emergency Fund
As you start to save, another common question that arises is where to keep your emergency fund. Often, setting up a separate account is a good idea, so the money doesn’t get mixed with your everyday spending or standard savings.
Also, considering the goal is to leave the money untouched, you may want to look for an account with a high-interest rate. Online savings accounts, high-yield accounts from credit unions, and money market accounts tend to offer higher rates than traditional banks’ checking and savings accounts.
Compare options from different financial institutions to find one with low fees and high-interest rates. Once you open an account, don’t forget to link it to your budgeting app so that you can watch it grow.
And remember, every little bit helps so keep saving and growing that emergency fund over time.