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What Is an Emergency Fund?

What Is an Emergency Fund?
Catherine Hiles
Updated August 11, 2022
5 Min Read

An emergency fund is a type of savings account where you keep money to help pay for unexpected events, such as emergency medical bills, car repair or replacement or unemployment. Let’s learn more about who needs an emergency fund, how much you should save in your account, where to save your money, and how to get started.

Who needs an emergency fund?

In short, everyone needs an emergency fund. Without an emergency fund, you may find yourself in financial trouble if you’re faced with an unexpected expense. But if you have an emergency fund in place, you can pay for these expenses without having to dip into your day-to-day budget or put the expenses on a credit card. In some cases, you may even need to take out a high-interest loan in order to pay a large and unexpected bill, which can quickly spiral into unmanageable debt. 

An emergency fund helps lessen the likelihood that you’ll have to take any of these options.

How much should you be saving in your emergency fund?

Any amount of money in an emergency fund is better than none, but ideally you should have about 3 to 6 months’ worth of living expenses saved up to help cover you in case you lose your job or other main source of income. 

However, if you are self-employed or freelance for a living, or even work seasonally, you should aim to save more than 6 months’ worth of expenses in your emergency fund. That’s because you don’t always have a regular paycheck when you freelance or work for yourself, so an emergency fund can help during those times when you have less work than usual.

The amount you should save also depends on your lifestyle and living situation. If you’re single and rent an apartment, you may only need enough in your emergency fund to cover a few months’ worth of expenses. However, if you’re married with kids and are the sole breadwinner for your family, a larger emergency fund is a good idea. Additionally, homeowners may choose to save more than renters since they are more likely to incur sudden house-related expenses, such as a broken air conditioning unit or a leaking pipe.

How to start an emergency fund

The thought of saving up 3 to 6 months’ worth of living expenses can seem daunting, especially if you’re living paycheck to paycheck. But it doesn’t have to be overwhelming. Here are some tips on how you can get started with your emergency fund.

Make a budget

In order to determine how much you can realistically save each month, it’s a good idea to come up with a budget. There are many apps and programs available to help you make a budget, or you can just go old school and use a spreadsheet. Many budget apps will connect directly to your bank account to automate your budget. The important thing is to account for all of your income and expenses so you can determine where you can afford to cut back so you can put that money in your emergency savings fund instead.

When making a budget, it’s a good idea to monitor your incomings and outgoings over a few months to look for any trends. Once you know where your money is going, you can categorize your expenses into either fixed or variable. Fixed expenses are the predictable ones that cost the same amount each month, such as rent, mortgage, insurance premiums, and utilities. Variable expenses are the ones that are less predictable, such as entertainment, meals out, and buying clothes or shoes. Once you have a good idea about how much money you’re spending in each category, you can make a realistic budget. Make sure you include all fixed expenses, as it’s important to pay those before putting any money toward your emergency fund.

Now, you can determine how much you can realistically save each month. The amount will depend on each person’s individual situation. It’s a good idea to also determine a good amount each month for things like restaurant meals or new clothes, since if you go cold-turkey on these expenses you’ll likely find it hard to maintain your budget. 

Set a goal

Once you have your budget laid out, you can set up a realistic savings goal. If your income is steady each month, you can determine a set amount or a percentage of your income to save. If your income varies from month to month you could set a quarterly savings goal or even a minimum amount to save each month and add to it if your income is over what you expected it to be.

It’s important to stay consistent with your savings. The easiest way to do that is to set up an automatic transfer for every paycheck, so your money hits your savings account before you even notice it in your checking account. That way, you don’t have to remember to transfer money into savings because it’s done automatically.

Save your change

Another way to save extra money is to save your change. In other words, for each purchase you make, round it up to the nearest dollar and put the difference in a savings account. There are several apps available that will do this for you automatically, as well as certain banks and checking accounts that will round up each purchase and deposit the change in a savings account. Unless you make a bunch of purchases each month, it’ll take a while to build an emergency fund this way, but it can be an excellent way to supplement your emergency savings without even missing the spare change.

Save extra income when possible

If you are lucky enough to receive a bonus, it’s a good idea to sock it away in your savings account. Or if you get a decent tax refund at the end of the year, you can put that toward your emergency savings as well. You can also ask for cash for occasions such as birthdays and add that to your emergency fund rather than asking for gifts you don’t need.

Monitor your account

Once you have a few months of savings under your belt, it’s a good idea to check your budget and savings account to see if you need to make any adjustments. Have you noticed that money has been extra tight since starting your emergency fund? It’s possible you can afford to decrease the amount you’re saving slightly to make more room for spending money on nights out with friends or takeout on nights you don’t feel like cooking. While saving is important, it’s also important to make sure you can consistently save each month.

On the flip side, you may find that you can save even more than you thought you could. In that case, you can increase the amount you’re saving each month in order to build your emergency fund even faster.

Where should you keep your emergency fund?

The best place to keep your emergency fund is in a high-interest savings account. That’s because in general, it’s easy to access funds from a savings account in case of a financial emergency. If you choose to invest your emergency fund money instead, you may find it hard to access the money when you need it.

An emergency savings fund is a must for just about anyone, and there’s no time like the present to start saving if you don’t already have an account set up.

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