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Setting up an emergency fund is an important step for financial security, but finding the cash can be tricky. Much as you might want to have a bundle of money waiting if you had a major medical bill due or endured a job loss, actually accruing an emergency fund may sometimes seem almost impossible. Monthly bills and expenses can siphon off your income, making it tough to save.
While it can be challenging, building an emergency fund can be done. It may take some time, but what’s important is to start saving and then keep it up, even in small amounts, to help protect your financial future.
Key Points
• Set a clear and achievable goal for an emergency savings fund, typically three to six months’ worth of expenses.
• When choosing an account for an emergency fund, a high-yield savings account may be an option to consider to help maximize growth.
• Cutting unnecessary expenses from a monthly budget can free up funds to put in an emergency account, as can windfall money like a tax refund or rebate.
• Automating savings with direct deposits can ensure consistent contributions.
• Use an emergency fund money only on real emergencies and work to replenish the account afterward.
What Is an Emergency Fund and Why Is It Important?
An emergency fund is a savings fund earmarked specifically for unanticipated expenses or financial emergencies that might crop up — such as job loss, major home repairs, or a medical procedure that results in a hefty bill. Financial professionals typically suggest having three to six month’s worth of income in an emergency fund.
An emergency fund is important because without this financial safety net, an individual might have to use high-interest credit cards or take out a loan to cover the emergency expense, which could result in having to pay down a significant amount of debt.
6 Steps to Building an Emergency Fund
Step 1. Set a Clear and Achievable Savings Goal
When it comes to the emergency fund amount you should have, most financial professionals recommend that you save three to six months’ worth of living expenses. Some people, however, may want to aim higher. If you are the sole provider for a family, have significant medical expenses, or are self-employed, you may want to allocate a higher amount, for example.
You can use an emergency fund calculator to help determine your savings target. Once you calculate that sum, you can divide it by 12 or 24 to get a one- or two-year savings plan for meeting the target.
The goal amount of your emergency fund may seem intimidating, but don’t let that discourage you. Even if you can only take a small amount ($25, say) from each paycheck as you save money from your salary, it will help make a difference.
Having some money in your bank account for emergencies is what matters.
Step 2. Choose the Right Account for Your Emergency Fund
The next important step is to get your emergency fund account set up. When choosing an account type, these are some considerations to keep in mind:
• Because an emergency fund is like a rainy day fund — you spend it only when a specific unexpected event warrants it, such as a costly medical procedure — putting it in a separate dedicated account can be helpful. Otherwise, if you leave the funds in your regular savings account, you might be tempted to spend the money.
• A savings account that could help your money make more money, such as a high-yield savings account, is one option to explore.These accounts can offer interest rates that are higher than those of standard savings accounts. And thanks to the power of compounding interest, your money may grow faster.
• Consider using savings vaults. These are essentially extensions of your savings account that let you organize your money into “buckets” and earmark it for specific goals, without having to set up a new account. That way, if you have a high-yield account, you can still earn the same competitive interest rate on your money and save for multiple goals at once, including an emergency fund.
Step 3. Find Room in Your Budget to Start Saving
If even a two-year timeframe for building your emergency fund amount feels intimidating, don’t worry. The important thing in terms of how to build an emergency fund is to begin saving and stick with it. If you only have a little bit of money to add per month, save that much. Good start!
Also, consider growing your savings by depositing windfall money in your emergency fund. Perhaps you’ll receive a tax refund, a bonus at work, a rebate, or other unexpected source of funds. Put that into your emergency account to help it grow.
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Step 4. Automate Your Savings With Direct Deposit
Depositing money into your emergency savings consistently can help your fund grow. And letting technology do the work for you can make it practically effortless. You could set up automatic savings transfers into your emergency fund just after you get paid, for instance. Or, if you have a side hustle, you might decide to automatically deposit 10% or 20% of those earnings into your emergency fund.
Not only will you reap the satisfaction of saving, if the money isn’t sitting in your checking account, you won’t be tempted to spend it.
Step 5. Start Tracking Your Expenses and Spending
If it feels like you just don’t have any cash available to put toward an emergency fund, consider ways to manage your money better and cut your budget a bit.
Perhaps you could eat out a bit less often, save on streaming services, shop for basics at warehouse clubs, or find other ways to trim back. Once you lower or eliminate some costs, you can put that extra money toward your emergency fund.
One thing to be alert for is “lifestyle creep.” This happens when, as you begin to earn more, you also spend more. In other words, as your income grows, so do your expenses, meaning you don’t build wealth. If you get a raise at work and then lease an expensive car, you may struggle to increase your savings.
However, if your spending stays in check, you can put a portion of your increased earnings toward your emergency savings account.
Step 6. Know When to Use Your Fund and How to Replenish It
Of course, you only want to tap your emergency savings account for a necessary and urgent expense.
An example of a financial emergency is a major home repair such as a roof that suddenly starts leaking. It could also be a car repair, like a blown tire that needs to be fixed so you can drive to work, a medical emergency that results in a hefty bill, or a job loss.
After you use your savings to help pay for an emergency, remember to replenish your emergency fund. That can ensure that you are prepared for the next unexpected expense that might pop up, which could help you achieve financial security. Otherwise, you could wind up drawing down your savings and have nothing left when needed.
To replenish your account, determine your new savings goal and start setting aside funds to help you reach it. Deposit any windfalls into your account, cut back on whatever expenses you can and put the resulting savings into your fund, or take on a weekend job to earn some extra income to replenish your emergency stash.
How Long Does It Take to Grow an Emergency Fund?
Emergency funds don’t necessarily come together overnight. Saving after-tax dollars to equal six months’ worth of typical living expenses can take some work and time. Here’s an example to consider: If your monthly costs are $3,000, you would want to have between $9,000 and $18,000 set aside for an emergency, such as being laid-off.
• If your goal is $9,000 and you can set aside $200 per month, that would take you 45 months, or almost four years, to accumulate the funds.
• If you can put aside $300 a month, you’d hit your goal in 30 months, or two and a half years.
• If you can stash $500 a month, you’d have $9,000 saved in one and a half years.
A terrific way to grow your emergency fund is to set up automatic transfers from your checking account into your rainy-day savings. That way, you won’t see the money sitting in your checking and feel as if it’s available to be spent.
Next, we’ll take a look at how to accelerate saving for an emergency fund.
How Can You Grow It Faster?
You’ve just seen how gradually saving can build a cash cushion should an emergency hit. Here are some ways to save even faster:
• Put a windfall into your emergency fund. This could be a tax refund, a bonus at work, or gift money from a relative perhaps.
• Sell items you don’t need or use. If you have gently used clothing, electronics, jewelry, or furniture, you might sell it on a local site, such a Facebook group or Craigslist, or, if small in size, on eBay or Etsy.
• Start a side hustle. One of the benefits of a side hustle is bringing in extra cash; it can also be a fun way to explore new directions, build your skills, and fill free time.
These techniques can help you ramp up your savings even faster and be prepared for an emergency that much sooner.
How to Start an Emergency Fund on a Low Income
Even when money is tight, you can still build an emergency fund. It may require some extra time and dedication, but every small step you take to grow your emergency fund amount can make a difference. Consider these tips to help reach your goal:
• Go over your budget carefully. Look for any expenses you could reduce and direct that money toward your emergency fund instead. For example, pack lunch for work and bring it with you every day. Then use your “lunch money” to help bolster your emergency savings.
• Get on a regular saving schedule. For example, you could automate the transfer of a small amount of money (say, $20) every payday into your emergency fund.
• Take advantage of “found” money. Use any windfall, such as a tax refund, a rebate, or a birthday gift, to help build your account.
How to Build an Emergency Fund in College
Creating an emergency fund as a college student gives you a cushion to deal with unexpected expenses you might face while in school, such as your laptop dying or your car breaking down. Methods to build up your emergency savings as a student can include:
• Use student discounts. Taking advantage of the deals you get as a student can help you maximize your savings at stores, restaurants, and other retailers. Put the money you save into your emergency account.
• Start a side hustle. You could get a weekend gig walking dogs, for instance. Or if you knit or make ceramics, try selling your creations on Etsy. There is no limit to what you can try. The benefit of a side hustle is that you’ll make some extra cash that you can put towards your emergency fund.
• Gamify your savings. You can give yourself fun challenges that help you save cash. For example, you might challenge yourself not to buy any fancy takeout coffee for a month and put the amount saved in your emergency fund account. The next month, you might skip yoga classes and instead practice at home. Again, deposit the extra cash into your emergency account.
How to Stay Motivated While Saving
Now that you know how to start an emergency fund, the next step is to stick with your savings goals. These tips for staying motivated could help.
• Find a buddy. Pair up with a friend or relative who is also trying to save, and support one another through the ups and downs of the process.
• Give yourself a pat on the back. Recognize that saving can be hard and that you may not hit your goal every month. But every time you put money in your emergency fund, you are doing something positive for your financial health. Be proud of yourself, and give yourself a little treat now and then to celebrate your accomplishment.
• Use available tools. Many financial institutions, as well as other companies, offer ways to automate, track, and build your savings. See what is offered that could help you save more easily.
The Takeaway
Starting and keeping an emergency fund can be an important step in achieving financial security. By keeping at least three to six months’ worth of living expenses in an interest-bearing account, you will have a cash cushion if you should hit one of life’s unexpected speedbumps. Automating the process, directing any windfalls to the account, and replenishing it after withdrawing funds are all important steps in the process.
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FAQ
What expenses qualify as an actual emergency?
Expenses that qualify as actual emergencies that you could use your emergency fund savings to pay for include a major home repair, such as a damaged or leaking roof; a large medical bill as the result of a sudden medical procedure; car repairs necessary for your vehicle to operate properly; and daily living expenses you have to cover after a job loss, such as rent, utility bills, insurance, groceries, and so on.
Where is the best place to keep my emergency fund money?
Where you choose to keep your emergency fund money is up to you, but one option is a high-yield savings account that offers rates higher than the rate of a standard savings account. This could potentially help your money earn more money. Plus keeping your emergency fund in a bank account keeps it liquid so that it’s easier to access when you need it.
Should I invest my emergency fund in the stock market?
Where you decide to put your emergency fund is a personal decision, however, many financial professionals advise against investing it in the stock market. That’s because the market can be volatile and there is the risk of losing money. Also, when an emergency strikes, you often need money quickly. Money that’s invested in the stock market is typically not liquid and may take time to access. For instance, you might need to sell stocks in order to get your cash.
How is an emergency fund different from regular savings?
An emergency fund is different from regular savings because the money is earmarked specifically for an emergency that might arise, such as an unexpected medical bill. Ideally, emergency fund savings aren’t used for anything other than emergencies, while regular savings may be used for a variety of other purposes, such as a down payment on a house, purchasing a car, or taking a vacation.
You may want to keep your emergency fund in a separate savings account so that you aren’t tempted to spend it on non-emergencies.
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