Emergency funds are your financial backup plan. The money you set aside creates a safeguard. It protects you from going into debt when you face large, unexpected expenses. Surprise medical bills or major car repairs could wipe out your savings. Instead of rolling the dice, start saving to take control of your financial burdens.
An emergency fund is a bank account with money reserved for unexpected, large expenses. You only withdraw the funds in an emergency, when you cannot cover a bill. The money you set aside provides a backstop so that you can avoid running up credit cards or taking on high-interest loans.
The right amount depends on your personal circumstances. Aim to save the amount that provides comfort. If you fall into financial hardship, like unemployment, then your emergency fund may be your last resort. The amount you save should prepare you and your family for that possibility. Saving 9 to 12 months of living expenses, for example, might prepare you for a long span of unemployment.
Put your emergency fund into a savings account to keep it safe. Opening a new account for the funds provides solid benefits. First, you will separate the money from your other accounts and reduce the temptation to spend it. Second, bank accounts carry FDIC insurance to protect up to $250,000 so your money remains safe. Third, many savings accounts offer interest so that you earn a return on your money from the bank.
Add up your monthly expenses, then multiply that amount by the number of months to cover. Your monthly expenses should include all of your typical bills and day-to-day necessary spendings, like rent, gas, and groceries. If you want to cover 12 months of expenses and you spend $1,000 in a typical month, then you need to save 12 x $1,000 = $12,000.
Make sure to cover all of your typical monthly expenses. For many families, this list includes rent, utilities, phone and internet, car, health and home/rent insurance, car gas and public transportation fares, monthly debt payments (like credit card bills), groceries, etc.
Saving monthly creates a good habit. It also breaks down your larger goal into achievable milestones. This makes saving feel less daunting. Use your budget to determine how much you can save. To see an example, check out our post on envelope budgeting.
Automatic transfers make saving even easier. If you receive direct deposit paychecks, consider sending a portion directly to your emergency fund bank account. If you do not, you can still automate transfers with online tools or apps. Apps can help you round-up spare change to deposit it into your emergency fund, transfer money based on personalized rules, and move funds on a set schedule.
“Extra” injections of cash can help you supercharge your emergency fund savings. Directly deposit these lump sums into your emergency account and you can be well ahead of schedule to build up your reserves. If you can direct deposit, even better.
Check on your emergency fund after a few months of saving. See how much you set aside, if your savings are on track, and if you need to adjust your monthly contribution up or down. Assessing your situation is especially important if you go through a major life event. Getting married, moving to a new city, starting a new job, and other major changes can impact your typical monthly expenses or automated transfers, like direct deposit.
Emergency funds and long term savings, like retirement accounts, are not the same. Your different accounts finance different goals in your life. Retirement accounts grow to support you when you no longer plan to work. Emergency funds might need to be used at any time in your life due to unpredicted events. Do yourself a favor and keep the money separate so that you do not jeopardize any of your financial goals.
Emergency funds prevent you from going into debt. Relying on credit cards or loans would only put you deeper in debt. Moreover, credit cards and loans can carry high-interest rates, steep payments, and inconvenient payment due dates. Sticking to a plan and building an emergency fund helps you avoid all of these problems. Of course, if an emergency strikes before you have saved enough, then you might want to consider all of your options to stay afloat, including balance transfer credit cards, personal loans, and other financing options.
Reading is the easy part. Things get hard when you start to apply what you learn. Growing your savings takes time, building smarter spending habits requires effort, and keeping tabs on it all can feel tedious.
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