Why to start an Emergency Fund
It’s not fun to think about, but planning an emergency fund can make a big difference in if you are able to weather the storm or if you face financial struggles as a result of unforeseen expenses.
According to a 2021 survey from Bankrate, 51 percent of Americans “have less than three months’ worth of expenses covered in an emergency fund”. That number includes about 25 percent who say they have no emergency fund at all.
Here are four steps to help you get started saving money for emergency fund.
Step 1: Understand the Purpose of an Emergency Fund
Before you start stashing money in a savings account, it’s important to know why you need to set aside money for an emergency. There are a number of reasons or situations that might come up in your lifetime (we’ll get to those in Step 3) that can bring with them a heavy financial price tag. During those times, an emergency fund is a useful resource that allows you to draw money from the account, without impacting your primary savings or checking balances.
Think of it as a financial backup system. When you have a well-stocked emergency fund, you are better prepared for the unexpected events that cause many people financial hardships.
Step 2: How Much Should Be in the Emergency Fund?
This is one of the most important questions to ask when starting to build your emergency fund. Like other successful endeavors in life, it’s important to have a goal for the fund and work towards it with a plan.
Most financial experts recommend between three to nine months of expenses saved in your emergency fund. This includes things like rent/mortgage, car payment, utility bills, groceries, etc. All of the essentials you need to get through the emergency. This is a good goal to have and it should give you enough resources to focus on the emergency.
To get started, you might look at setting aside $25 or $50 a week into a savings account (or more if your budget allows). You will see the account build, and even be prepared for smaller emergencies as you work on the full six-month reserve.
Step 3: Define What Qualifies as an Emergency
The trick with a maintaining a good emergency fund is to not be tempted to use your savings on non-emergencies. While you may eventually have several thousand dollars saved, don’t make the mistake of taking from it unnecessarily. When a true emergency does come up, you won’t be prepared.
So, what qualifies as an emergency? That’s ultimately up to you to decide, but here are a few ideas to get you started:
- Job loss
- Urgent medical treatment
- Identity theft / Fraud
- Major car repair
Step 4: Find the Account That’s the Best Fit
When you know how much you want to save and what you plan to use those savings on, it’s time to decide which type of account is the best fit for your money. You’ll want something that both earns interest and has liquidity. This means that while your money sits in the account, it generates earnings for you, but it also gives you the ability to withdraw from it without penalty.
Options like a certificate of deposit might not be the best route, as you normally have to lock your money in for a specific term—sometimes up to 55 months—or incur a penalty. In an emergency, you will need access to your funds fast. Consider these account options:
- High-yield savings account
- Money market account
- Mutual funds
The best advice for an emergency fund is to save what you can and have the discipline to keep it stored. As the saying goes, it’s better to have it and not need it, then need it and not have it.