What is an emergency fund?
An emergency fund is a bank account with money set aside to pay for large, unexpected expenses, such as:
Unforeseen medical expenses.
Home-appliance repair or replacement.
Why do I need an emergency fund?
Emergency funds create a financial buffer that can keep you afloat in a time of need without having to rely on credit cards or high-interest loans. It can be especially important to have an emergency fund if you have debt, because it can help you avoid borrowing more.
“One of the first steps in climbing out of debt is to give yourself a way not to go further into debt,” says IHowBlog columnist Liz Weston.
How much should I save?
The short answer: If starting small, try to set aside at least $500, but work your way up to half a year’s worth of expenses.
The long answer: The right amount for you depends on your financial circumstances, but a good rule of thumb is to have enough to cover three to six months’ worth of living expenses. (You might need more if you freelance or work seasonally, for example, or if your job would be hard to replace.) If you do lose your job, you could use the money to pay for necessities while you find a new one, or the funds could supplement your unemployment benefits. Start small, Weston says, but start.
Having even $500 saved can get you out of many financial scrapes. Put something away now, and build your fund over time.
Where do I put my emergency fund?
A savings account with a high interest rate and easy access. Because an emergency can strike at any time, having quick access is crucial. So it shouldn’t be tied up in a long-term investment fund. But the account should be separate from the bank account you use daily, so you’re not tempted to dip into your reserves.
A high-yield savings account is a good place for your money. It is federally insured up to $250,000 per depositor, so it’s safe. The money earns interest, and you can access your cash quickly when needed, whether through withdrawal or a funds transfer.
How do I build an emergency fund?
Set a monthly savings goal. This will get you into the habit of saving regularly and will make the task less daunting. One way to do this is by automatically transferring funds to your savings account each time you get paid.
Move money into your savings account automatically. If your employer offers direct deposit, there’s a good chance they can divide your paycheck between multiple checking and savings accounts so that your monthly savings goal is taken care of without touching your checking account.
Keep the change. Use mobile technology to save automatically each time you make a purchase. There are savings-focused apps that link with checking or other spending accounts to round up the purchase amounts on your transactions. The extra amount is automatically transferred to a savings account.
Save your tax refund. You get a shot at this once a year — and only if you expect a refund. Saving it can be an easy way to boost your emergency stash. When you file your taxes, consider having your refund deposited directly into your emergency account. Alternatively, you can consider adjusting your W-4 tax form so that you have less money withheld. If modifying your deductions is a good option for you, you can direct the extra cash into your emergency fund.
Assess and adjust contributions. Check in after a few months to see how much you’re saving, and adjust if needed, especially if you recently withdrew money from your emergency fund. On the other hand, if you’ve saved up enough to cover six months of expenses and have extra cash, you might consider investing the additional funds instead.
When saving, draw a line between emergencies and everything else. In fact, once you’ve hit a reasonable threshold of emergency savings, Weston says, it’s a good idea to begin another savings account for irregular but inevitable items, such as car maintenance, vacations and clothing. If you need help staying organized, many banks allow customers to create and label sub-accounts for different financial goals.
Everyone needs to save for the unexpected. Having something in reserve can mean the difference between weathering a short-term financial storm or going deep into debt.
Use this calculator to get started. It takes only a few minutes: