Emergency Fund: What It Is and Why It Matters
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.
- Major car fixes.
- Unemployment.
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.
How much should I save?
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. 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, 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?
In a savings account that earns interest 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.
How do I build an emergency fund?
- Calculate the total that you want to save. Figure your expenses for six months.
- 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 debit card purchase. Have the rounded-up amount automatically transferred to your emergency savings account. If you usually spend cash, you can take your spare change, or maybe $1 and $5 bills after breaking a $20, and drop some in a jar at home. When the jar fills up, take it to the bank and deposit the cash.
- 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 adjust your W-4 tax form so that you have less money withheld. Then 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.
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