Life is full of surprises, good and bad. Whether you are faced with car repairs, a large medical bill, or last-minute travel expenses, financial emergencies will not wait for you to be ready for them. But, you can avoid letting these types of surprises turn into major financial burdens by using an emergency fund to help you stay on track towards your financial goals. Your emergency fund is essential to building financial security and peace of mind. Keep reading to learn more about building your emergency savings fund.
What is an emergency fund?
An emergency fund is a dedicated, accessible cash reserve that is set aside specifically for large, unplanned expenses. Think of your emergency fund as a financial safety net that provides a buffer between you and potential setbacks. According to a study by Empower, more than 1 in 5 (21%) Americans have no emergency savings. In a world where the average car repair costs $1,452, a well-funded safety net can be the difference between staying the course towards your financial goals and being forced into debt.
Why do I need an emergency fund?
Once established, your emergency fund is the first line of defense when you have an unexpected, necessary, and urgent cost, like a hospital visit or a home repair not covered by insurance. Your emergency fund will help you take care of those substantial expenses that you cannot plan for. Avoid the temptation of reaching for a credit card, taking out a personal loan, or withdrawing from your hard-earned retirement savings. These methods could come at the cost of additional financial burden, such as fees, interest, or loss of future retirement income. Instead, cover the expense with your emergency fund, get through the time of crisis, and then work toward rebuilding for the future.
How much should I save for an emergency fund?
To start, shoot for a starter fund of $1,000. This initial amount will not cover every situation, but it will help take care of emergencies that come up when you are working toward a fully funded account. After you achieve the $1,000 starter fund, aim to set aside enough money to cover three to six months of essential living expenses. Ensure you have enough in your emergency fund to cover:
- Housing: Rent or mortgage payments, utilities, homeowners or renters insurance
- Food and necessities: Groceries, toiletries
- Wellness: Health care, health insurance
- Family: Childcare, tuition
- Transportation: Gas, public transportation, car insurance
- Debt: Minimum payments on loans and credit cards
Where should I keep my emergency fund?
Ensure that your emergency fund is liquid, meaning you can access it quickly and easily. Consider these types of accounts offered at many financial institutions:
- A savings account that allows transfers to your checking account
- A money market account that offers a debit card or checkbook
- A high-yield savings account with a higher interest rate and electronic funds transfer
Some account types might have minimum balance requirements, maximum withdrawal frequencies, or other restrictions that might limit access to funds in the event of an emergency. If you work with an institution that imposes these restrictions, plan accordingly so you can access funds when you need them.
Alternatively, you can have an emergency fund available in cash, so long as you have a safe place to keep it. Unfortunately, a cash emergency fund could be lost, stolen, or destroyed. You can also consider keeping a portion of your emergency fund in a short-term certificate of deposit (CD), with the understanding that you should draw from a more liquid source first to avoid potential withdrawal penalties.
How do I start or build my emergency fund?
Approach your emergency fund like a monthly bill. Start by saving a little each month toward your goal. You can set up a direct deposit from your paycheck into a dedicated account, or you can initiate monthly automatic transfers from your checking account. Use life’s good surprises, like a bonus, raise, or other influx of cash, toward your emergency savings. Look at your monthly budget and see if you can make any changes that could free up more cash, such as canceling subscriptions, cutting back on dining out, and limiting entertainment purchases.
When do I use my emergency fund?
Before you dip into your emergency fund, see if you can cut back on other spending to cover a surprise expense. If the expense turns out to be a recurring cost, it might be time to adjust your budget. However, if the cost is unexpected, necessary, and urgent, it may require using your emergency fund to cover it. After you withdraw funds, prioritize replenishing your emergency savings.
Building an emergency fund that covers three to six months’ worth of expenses takes time and discipline, but the benefits far outweigh the effort. A financial safety net in the form of an emergency fund allows you to handle life’s surprises with confidence and maintain focus on long-term financial success. Start saving today—your future self will thank you!
Clarissa Flynn is the Content Specialist for the Fire & Police Pension Association of Colorado. When not delivering meaningful emails, social media, and blog posts to FPPA members, Clarissa enjoys exploring Colorado state parks and picking up new crafting hobbies.