Last Updated on November 21, 2023
Building an emergency fund is an important part of preparing for the unexpected. Hopefully, you’ll never have to use it, but if you suddenly have a big medical expense, need to pay for car or home repairs, or lose your job, having emergency savings in place saves you a lot of stress. Let’s look at what constitutes an emergency fund, how to budget for one, and how to save up for one even when finances are tight.
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An emergency fund is money you save up so you’re prepared for unexpected financial needs. Let’s face it: life is unpredictable. Jobs end, cars break down, pipes burst, or you or a family member could need medical care. When you find yourself with surprise bills or shortfalls, emergency savings can help you make it through without going into debt. While credit cards and loans are always an option, an emergency fund can help you pay the bills immediately, without the addition of ongoing payments and added interest.
Generally speaking, an emergency fund should cover your living expenses for three to six months. Living expenses include your basic needs, like rent or mortgage, bills, and groceries. If you are the sole or primary earner in your home, you should save up enough to cover all your dependents, including your partner, children, and any other family members you are financially responsible for.
It takes time to build up emergency savings of this size, though, so remember that saving any amount helps. Start by saving one month’s mortgage payment or rent, and then add as much as possible whenever possible. If you keep it top of mind and add to it as often as you can, your emergency fund will grow surprisingly fast.
It’s important to keep your emergency savings in a secure, dedicated location. You have several options for doing this, including:
You can put your savings in short-term investments, like CDs or short-term bonds, that offer higher returns on your savings than a savings account. These do come with more risk, however, as the investment value fluctuates with the market. Additionally, if you withdraw your money before a certain period of time (often six months), you may have to pay a penalty.
You can also set up a federally insured dedicated savings account, allowing you quick and easy access to your money whenever you need it. A high-yield savings account is preferable, as it builds interest at a higher rate than a standard savings account, allowing your savings to grow faster. A high-yield account should also come with fewer fees than a traditional savings account. That said, a traditional savings account will also work just fine.
We wouldn’t recommend only doing this, but for some people, saving actual cash in a safe or a safety deposit box can make building an emergency fund easier to start and/or continue. Physically seeing your stockpile of cash grow can be a powerful incentive to keep contributing to it. Just remember that cash can be vulnerable to physical interference (theft, loss, natural disasters) and that it doesn’t grow over time through interest or market growth—in fact, thanks to inflation, cash will actually decrease in value over longer periods of time. So if starting with cash works for you, great, but consider moving the emergency fund into a savings or investment account eventually.
Whichever option you choose, the point is to start saving as much as you can, so if deciding where to put the money might delay you, don’t worry about that yet. Just put the money aside in a separate, secure place so you don’t accidentally spend it.
As soon as possible. The sooner you start saving, the more time your emergency savings will have to grow, and the more money you’ll have when you need it. You may not have a lot of extra money at times, which means your emergency fund may start small or grow slowly, but that’s okay. As long as you add to it when you can, you’re in better shape than you would be without it.
Saving up for unexpected financial situations benefits you, your budget, and your well-being. Here are some of the benefits you’ll enjoy once you have an emergency fund.
Not knowing how you’ll pay for the unexpected is frightening. Knowing you have an emergency fund for difficult financial situations helps you to weather the storm. You can cover your basic necessities, so even if things are tough, you won’t have to worry about an empty fridge.
Credit cards can be handy, but they also make it easy to rack up debt quickly. The more you put on that credit card, the more interest you accrue, and the harder it is to pay it off—which makes living with it that much more stressful. An emergency fund helps you pay for things as needed and repay your savings when your financial situation improves, without taking on more debt.
As we just noted, an emergency fund can save you from increasing your debt when the unexpected comes your way. This helps keep your debt-to-income ratio lower, and the lower your ratio, the better your credit score. Better credit lets you qualify for lower interest rates and fewer fees when it’s time to apply for a loan, credit, or new banking accounts later, benefitting your financial standing in the long run.
Starting emergency savings might be intimidating at first, but just remember: every little bit counts. Start by budgeting to help you avoid extra spending. Here’s how.
- Create a monthly budget: This helps you identify how much you can save each month, and tells you how much you’ll need to save for a six month emergency fund.
- Set a monthly savings goal: Choose an amount that works for your budget and stick to it.
- Save extra money: Save cash left at the end of month, monetary gifts, or bonuses at work to help your savings grow faster. You could also take steps to make extra money using these ideas.
- Curb unnecessary spending: Avoid eating out, find free entertainment, and pause or cancel any monthly purchases or memberships you don’t need.
- Reassess regularly: Monitor your spending and savings and make adjustments to save a little more each month.
Sometimes, just paying closer attention to your spending is enough to help you save up a good chunk each month. Most importantly, make sure you reserve your emergency fund for true emergencies rather than spending it on other wants and needs.
Emergencies happen, whether you’re fully prepared or not. If you haven’t started your emergency fund yet, or haven’t saved as much as you need, a personal loan can help you get the cash you need right away. You’ll receive a one-time lump sum of cash, which can help you pay off your expenses. Loans also typically have a lower interest rate than credit cards, and since it’s just one payout, you won’t rack up additional debt with continued use. Make sure you make payments in full and on time each month to build credit, too.
There are options available to help you cover unexpected financial situations. But the best option is to crisis-proof your finances by having your emergency fund ready for you when you need it. As soon as you can, start building emergency savings to get you through the unexpected without making a difficult time even harder.