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Establish an Emergency Fund that Works for You
Keeping money in a dedicated emergency fund may help prepare you for unexpected expenses.
Did you know that nearly 37% of Americans can’t afford a $400 emergency?1 Between rising inflation, increased housing costs, and wage stagnation, it probably shouldn’t be a surprise. But an emergency fund could help you prepare for unexpected situations without forcing you to rely on high rate credit cards or dipping into your personal savings.
There’s more to establishing an emergency fund than simply deciding you need one. You need to open the right type of savings account and determine your savings goal based on your lifestyle.
Let’s look at how emergency funds could help you be ready if you encounter a lean time and how to build one that fits your needs.
Key Takeaways
Emergency funds are safety nets that help cover expenses during unexpected financial emergencies.
Most people should aim to save between three and six months of living expenses in their emergency fund.
Having a separate savings account for your emergency fund may reduce the risk of using the money for non-emergency expenses.
What Is an Emergency Fund?
An emergency fund is a safety net that could help you cover unexpected expenses like medical bills, major car or home repairs, or even losing your job. These savings are separate from your checking account and other savings and should only be used for emergency purposes.
It may be easier to open a dedicated savings account for your emergency fund. By separating your emergency fund from general savings, you may reduce the temptation to spend it on non-emergency situations.
Emergency Funds Vs. Rainy Day Funds
When people think of emergency funds, they often mistake them for rainy day funds. Though both help cover surprise expenses, they have different purposes.
Emergency funds exist to support you through a major financial crisis, such as a job loss. Rainy day funds typically cover smaller unexpected expenses, like replacing an appliance or covering an unexpected vet bill because Fido ate a squeaky toy. Again.
Since rainy day funds cover smaller expenses, most people don’t earmark as much money for them as they do emergency funds. Both funds are worth having, but you probably want to keep more money in your emergency fund.
Why Do You Need an Emergency Fund?
Building your savings is a great way to improve your financial well-being. But having a specific emergency fund may be a good idea even if you have significant savings for general purposes.
Some benefits of creating a dedicated emergency fund may include2:
Lower stress levels. Having an emergency fund may result in less stress over money since you won’t’ have to wonder how you would pay for unexpected expenses.
Reduce impulse spending. Building up dedicated savings may make you less tempted to use those funds for impulse purchases.
Take on less debt during financial hardships. These funds may help cover unexpected costs, which may reduce the need to take out a personal loan or wrack up additional charges on high-rate credit cards to make ends meet.
How Much Money Should You Save in Your Emergency Fund?
Experts recommend having three to six months of expenses saved in your emergency fund, but the exact amount you need depends on your financial situation and the types of expenses you have each month.3
To help set your savings goal, follow these steps:
Think about the expenses you have each month. You may want to track your expenses for a month or two to get a feel for how much you spend on the items you need.
Remove any non-essential expenses you’d cut out during an emergency like eating out or streaming subscriptions. You want to have enough money saved to cover your rent or mortgage payment, utilities, insurance, groceries, and other essential costs.
Total the remaining numbers up.
Figure out how long you expect an emergency to last. Keep in mind that this may be several months.
Multiply your total essential expenses by the number of months you expect your emergency to last.
Let’s look at how this might play out in real life. Say your essential expenses look like this:
Rent/mortgage payment: $1,500
Utilities (water, sewer, electricity, etc.): $300
Groceries: $500
Insurance: $100
Car payment: $320
Your total essential monthly expenses come to $2,720. To save the recommended three to six months’ worth of living expenses, you need to set aside between $8,160 - $16,320.
Revisit this goal on a regular basis or whenever you experience a major life change, such as having a child or getting married. As your essential expenses change, you may need to set more aside.
Where to Keep Your Emergency Savings
Many people find it easier to keep their emergency fund in a separate savings account rather than comingling the money with their regular savings.
When setting up a dedicated emergency fund, make sure you’re choosing the right account for your needs and goals.
You want these funds to be easily accessible since emergencies could happen at any time. You also want your money to be safe and to grow over time at a competitive rate. As you search for a savings account, look for the following:
Be NCUA or FDIC insured, so your money is safe even if the bank fails.
Have high rates, expressed as Annual Percentage Yield (APY), so your money grows faster over time.
Be easily accessible. Look for features like digital transfers or automatic deposit so you’re able to add or withdraw from your account as needed.
Savings Account Types You Can Choose From
Opening a dedicated savings account for your emergency fund is a great way to keep yourself from spending the money on other purchases. When choosing the right savings account for your emergency fund consider the following types.
A high-yield savings account: High-yield savings accounts typically offer higher APYs than traditional savings and checking accounts.
A money market account: Money market accounts allow you to easily make contributions and withdrawals, much like a high-yield savings account. These accounts typically have higher APYs than traditional saving accounts and limit monthly withdrawals, reducing the temptation to spend funds on non-emergency situations.
A traditional savings account: If your bank or credit union doesn’t offer a high-yield account and you don’t want to open an account with another institution, opening a traditional savings account may be an option. Keep in mind that your money will likely grow more slowly since these accounts typically have low APYs.
How to Build an Emergency Fund
Setting money aside on a regular basis is tough if you’re not sure where to start. Here are a few tips to help you build your emergency savings.
Set a clear savings goal: Calculate how much you need to have on hand for a crisis. Factor in your necessary costs like rent, utilities, groceries, and insurance. Remember, you may want to save between three- and six-months’ worth of living expenses.
Set monthly targets: Staying motivated can be tough when you have other expenses you want to cover. Instead of focusing on your total savings goal, consider breaking it down into monthly targets. As you reach those targets, be sure to celebrate to help you stay motivated.
Use automatic transfers: Remembering to set money aside when you’re juggling work, social and personal responsibilities, and other obligations may not be easy. Instead, set up automatic transfers each month and put your savings on autopilot.
Look for ways to cut costs: The less money you spend each month, the more you could save. Look at your expenses and see if there are any costs you could reduce or eliminate. Use the money you were spending to cover those costs to build your savings faster.
Watch for higher rates: Your emergency fund could grow faster when you choose a savings account with a high APY. Don’t hesitate to compare rates at different banks, and if you find one that offers better rates than your current financial institution, consider switching.
Keep these tips in mind and you’re on your way to building your emergency fund.
When Should You Use Your Emergency Fund?
As we mentioned earlier, emergency funds should be used for significant financial difficulties. This means you should avoid using the money for spontaneous purchases like buying a new TV or stocking up on this season’s latest sneaker styles. (A splurge fund could help you handle those types of purchases!) But every situation is unique and what qualifies as an emergency to one person may not be for another.
Think about what you’d consider to be an emergency. You may even want to write a list that you could consult if you’re struggling to determine if a situation qualifies.
An emergency may be something like losing your job, getting injured and having medical bills to pay, or your car breaking down and needing thousands of dollars in repairs.
Use your funds to cover costs that are emergencies to you. Just be sure to build your fund back up after the situation passes so you’re prepared for the next one.
Final Thoughts
Establishing an emergency fund may be one of the easiest ways to set yourself up for financial stability in the long run. By creating this fund now, you’re more likely to be able to build up reserves that you could use to help cover emergency expenses when they pop up.
Looking for a home for your emergency fund? Consider a Jenius Bank savings account.