Life can be unpredictable. Car breakdowns, medical bills, or unexpected job loss can wreak havoc on your finances. That’s where emergency funds come in! Your emergency fund is your financial safety net that can catch you when life throws curveballs.
This ultimate guide will equip you with everything you need to build a rock-solid emergency fund and achieve financial peace of mind.
What Exactly Constitutes An Emergency?
Well, an emergency is NOT a really good sale at your favorite store. It’s not forgetting to buy a gift for your friend’s birthday. It’s not even a home repair – unless the issue that needs to be fixed will destroy your home.
Your emergency fund is available if you lose your job, if you have a medical emergency, or if you have another significant financial event. It’s important to be strict about when you use your emergency fund – otherwise, the money won’t be there when you really do need it!
How Much Should You Save?
A common question is: how much should I have in my emergency fund? Most experts recommend saving 3-6 months’ worth of living expenses in emergency funds. This ensures that, in the event of an emergency, you’re covered for a significant period of time while you get back on your feet.
Here’s the key: be realistic. Don’t just use your salary; factor in essential expenses like rent, utilities, groceries, and minimum debt payments.
Also, consider your specific circumstances. Three to six months may be the standard rule, but a single-income family with kids may want to save six to nine months, whereas a dual-income couple with no dependents may be fine with only three months. Also, if your income fluctuates – if you are an entrepreneur or freelancer – you may want a full 12 months of expenses saved, just to be safe.
On the other hand, you don’t want too much in your emergency fund because your emergency fund is NOT invested, so it is not earning you money over time.
Building Your Emergency Fund
Building an emergency fund takes discipline, but it’s achievable! Here are some actionable steps:
Set a SMART Goal:
A SMART goal is Specific, Measurable, Achievable, Relevant, and Time-bound. Make your emergency fund goal specific; instead of having a goal to “save more,” be specific and plan to save “$1,000 in 3 months.”
Put Your Emergency Fund into Your Budget:
When you make your budget, include a line item to save for your emergency fund. Every month, set aside a certain amount to build up your emergency fund, and stick to it! Saving your emergency fund should be a priority!
Track Your Expenses:
We think we know where we spend our money, but, in my experience, we really don’t know how we are spending our money until we track our spending for a few weeks to a month. So, track your spending for a month, then identify spending areas that are less important to you than saving for your emergency fund.
For example, can you brown-bag lunch a few times a week? Streamline subscriptions? Cut-back on miscellaneous spending? If so, direct those savings into saving up your emergency fund and you will be surprised how quickly you will save a completed emergency fund!
Automate Savings:
Once you determine how much you can direct each month from your budget to saving for your emergency fund, set up an automatic transfer from your checking account to your emergency fund savings account. This will remove the temptation to spend the money and ensure consistent savings to achieve your emergency fund goal.
Where to Keep Emergency Funds
The most important thing is that your emergency fund be easily accessible in the case of … an emergency! So, accessibility is key. Here are some secure, liquid options:
High-Yield Savings Account:
High-yield savings accounts earn more interest than regular savings accounts and they can be a great place to keep your emergency fund. However, each high-yield savings account has its own rules and restrictions so do your homework! Find a high-yield savings account with low/no minimum balance, low/no restrictions on deposits and withdrawals, and that allows easy transfer to your checking account in the event of an emergency. The right high-yield savings account will allow you easy access to your money while also allowing you to earn a little extra interest.
Money Market Account:
Money market accounts are also a great choice for your emergency fund. These accounts usually offer slightly higher interest than regular savings accounts while keeping your emergency fund readily available. Most money market accounts also allow check-writing, which is perfect in the case of an emergency.
Pro Tips for Emergency Fund Success
Celebrate Your Milestones!
It is motivating to reach your savings goals, so reward yourself (within reason!) when you achieve milestones towards your financial goals. Celebrating your wins will help you to persevere for the length of the journey!
Review Regularly:
Your emergency fund is not stagnant! As your life changes (income increase, family additions, inflation), you need to adjust your emergency fund to ensure it remains sufficient. If you are making a monthly budget (and you SHOULD be!), you can re-evaluate whether your emergency fund is sufficient each year. Each year on a set date – your birthday, the fall time change, the first day of spring, you choose – recalculate your emergency fund needs and, when it changes, make a plan to save the difference as soon as possible.
Emergency Funds vs. Other Savings Goals:
Having an emergency fund protects your other savings from being “stolen” for an emergency. Therefore, it is important to prioritize saving your emergency fund first. Once you have your emergency fund in place, you can save for other financial goals without worrying that your savings will be “taken” in the event of a financial emergency.
By following these steps and adopting a mindful approach, you’ll build a robust emergency fund and achieve true financial security.
Bonus Tip: Consider incorporating a “windfall strategy.” When you receive unexpected income (bonus, tax refund, financial gifts), allocate a portion to your emergency fund for a quick boost.
Remember, emergency funds are insurance for your peace of mind. With a little planning and discipline, you can build your financial safety net and weather any storm life throws your way.