Finance

What Is An Emergency Fund And How To Start One

Unexpected emergencies — like when your tire blows out on the highway or you fracture your ankle on vacation  — can be really stressful events.

They also can be really expensive.

And because you don’t often anticipate the worst-case scenario happening at any given moment, these unplanned events can steamroll your financial standing. That is, if you don’t have an emergency fund in place.

What Is an Emergency Fund?

An emergency fund is that safety net you can fall back on when the unexpected happens.

It isn’t a credit card that you can swipe or a family member you can borrow money from. It’s a stash of cash set aside (preferably in a high-yield savings account or money market account) that you can easily access when needed.

Why Do You Need an Emergency Fund?

Emergency funds reduce the stress you’ll feel during financial emergencies, like if your pet needs an urgent surgery or you lose your job.

Without emergency savings, you might wind up spending the money you need for your monthly bills, sinking into credit card debt or taking out a personal loan when unexpected financial emergencies occur.

Having an emergency fund should be among your top financial goals if you don’t currently have one. Here’s how to get started.

How to Start an Emergency Fund

Follow these steps to get started building an emergency fund today, so you can handle your next unexpected predicament without maxing out credit cards, taking out a loan or tapping into your home equity.

1. Determine How Much Money You Need Saved for Emergencies

The general rule of thumb touted by many personal finance professionals is to have three to six months’ worth of expenses stored up in your emergency fund.

That doesn’t necessarily mean you need a minimum of triple your monthly household income. But ideally you’d have at least three times the amount of money it takes to keep your household running for a month.

Look at your budget — or the past few months’ worth of bank statements — to figure out the amount of money it takes for you to live. This doesn’t include what you spend dining out or on clothes or on cable. Those things can be easily eliminated if you had to drop down to a bare-bones budget after a job loss.

You don’t need a fancy emergency fund calculator to determine the amount you should have for your emergency savings. Simply take the total of your monthly essential expenses and multiply it by 3.  If you’re able to save for six months instead of three, even better.

If it feels intimidating to try to save that much, start by breaking your savings goal into smaller chunks. Focus on saving $500 and build from there to eventually reach your emergency fund goal.

Pro Tip

Make each mini goal specific, measurable, attainable, relevant and timely. People tend to be more successful when goals are framed as SMART goals.

You’ll hear some financial experts, like Dave Ramsey, talk about having an emergency fund with just $1,000. (Ramsey’s famous money management plan — known as “baby steps” — does urge followers to save three to six months of living expenses, but not until after paying off all non-mortgage debt.)

However, keep in mind that your emergency fund is all about giving you peace of mind that you’d be able to weather a crisis and cover unexpected expenses. Accredited Financial Counselor Kumiko Love told The Penny Hoarder she tried Dave Ramsey’s plan but didn’t stick to it because as a single mom she thought $1,000 wouldn’t be enough to get through a true emergency.

“I was up at night worried that I didn’t have enough for safety in my emergency fund,” Love said.

Also, consider that if your car insurance deductible is $1,000, and you got into a serious accident, you wouldn’t have enough money saved to cover car repairs plus medical expenses and any other costs.

Though three to six months of expenses is the standard, your goal for your emergency fund may vary depending on your situation. If you’re the sole breadwinner of your family or you work in a field where it’d be tough to quickly get another job in the event of a layoff, you might want to save up more than six months of living expenses.

2. Figure Out Where You’ll Keep Your Emergency Fund

It’s important to keep your emergency savings fund liquid and easy to access. Avoid locking your money in a savings vehicle where you’d encounter penalty fees by withdrawing it in an emergency, such as a 401(k) account or a five-year certificate of deposit. While investing your savings could help it grow, you don’t want to risk losing your emergency funds.

Michael Gerstman of Gerstman Financial Group recommends you keep your emergency fund in a no-risk account, like an FDIC-insured savings account or money market account.

A high-yield savings account typically has a higher interest rate than regular savings accounts. So do money market accounts.

Best High-Yield Savings Accounts

Stashing your cash in a checking account is another option, though most won’t earn you as much interest.

Make sure you store your emergency fund in an account where you won’t be tempted to spend the money. Consider online savings accounts or a bank account without a debit card if you feel you might be enticed to make unnecessary withdrawals. Putting your savings in a different bank or credit union than where your main checking account is will add another layer of separation.

3. Find Ways to Add to Your Emergency Fund

A mixture of regular savings contributions and lump-sum deposits will build the balance quickly.

Have your employer split your direct deposit so a portion of each paycheck goes to your emergency fund, or set up automatic transfers to your savings account after each payday. When you don’t see the money in your main checking account, you won’t be tempted to spend it.

If your budget is tight, you could cut your spending by switching over to the cash envelope system, canceling monthly subscriptions, joining a Buy Nothing group or switching to less expensive service providers. Or you could increase your income by taking on a side hustle or working a second, part-time job.

You can also increase the amount of money in your emergency savings account by depositing any extra cash you receive from one-time windfalls. Sell items around your house that you don’t use or could part with. Crash with friends for a week and rent out your home on Airbnb. Transfer work bonuses and your income tax refund over to your rainy day fund before you spend a dime.

4. Know When (and When Not) to Tap Into Your Savings

It’s not enough to know how to start an emergency fund. You must also understand what qualifies as a good reason to take money out — and when you should leave it alone.

It can be tempting to see thousands of dollars in your account, but avoid using that cash unless you have unexpected expenses due to true emergencies.

A good rule of thumb is to avoid spending your emergency cash on expenses that can be predicted, like routine car maintenance, a large annual insurance bill or summer camp enrollment. You don’t want to build an emergency fund only to spend that money on expenses you could have prepared for. Set up separate sinking funds for those savings goals instead.

And keep in mind, once you’ve spent money from your emergency fund, you’ll need to replenish it so you’re prepared for the next big thing that comes your way.

Frequently Asked Questions (FAQs) About Starting an Emergency Fund

There are lots of ways to start an emergency fund and lots of questions about which way might be right for you. Here are answers to the mostly common questions.

How Much Should I Have in an Emergency Fund?

Experts typically advise saving at least three to six months of necessary expenses in an emergency fund. These are monthly expenses that you have to pay to survive (and avoid falling into debt), like a mortgage or rent, utilities, groceries, transportation, health care and credit card minimum payments. But saving up for three to six months of expenses is no easy task; you can start smaller — even if it’s $100 from each paycheck — until your emergency fund is big enough.

Where Should I Keep My Emergency Fund?

some interest. For example, a high-yield savings account or a money market account makes it easy to access your money when you need it, but it will also earn interest as long as you leave it in the account untouched. If you are worried you’ll spend the money on non-emergencies, you might benefit from opening a separate account at a different bank, solely for your emergency savings. Avoid no-interest checking accounts where you might be tempted to spend the money, and also stay away from less liquid options, like CDs and 401(k) accounts.

When Should I Use My Emergency Fund?

You should use your emergency fund to cover unexpected emergency expenses, like a major car repair, a high medical bill or even regular monthly expenses if you lose your job. If you have other irregular, but anticipated, expenses that might only come up once or twice a year (like a lump-sum auto insurance payment or school supplies), try not to use your emergency fund for them. Instead, you can set up separate sinking funds to cover these purchases.

How Can I Increase My Emergency Fund Faster?

If you’re having trouble getting to the recommended three to six months of expenses in your emergency fund, you’ll have to get creative. Take up a side gig for an influx of cash, get rid of unnecessary expenses like a streaming service you rarely use or pause some of your other more enticing savings goals, like an upcoming vacation. Your savings account may even have automatic savings features that help you reach your emergency fund goals faster.

Do I Need an Emergency Fund?

Emergency funds are one of the most important savings goals a person should have. Before you save for fun things like vacations or a wedding, and even before you start investing in a retirement account, it’s a good idea to build an emergency fund. These funds can keep you from going into debt if you’re in a car accident you lose your job or you, your kids or even your pets have an unexpected medical bill.

Nicole Dow is a former senior writer at The Penny Hoarder and contributor Timothy Moore updated this report.




Source link

Show More

admin

Makes Noise is a blog where you can find all the juicy details on a variety of topics including health and fitness, technology, lifestyle, entertainment, love and relationships, beauty and makeup, sports and so much more. The blog is updated regularly to make sure you have all the latest and greatest information on the topics that matter most to you.

Related Articles

Leave a Reply

Your email address will not be published.

Back to top button