Why You Need an Emergency Savings Fund and How to Build One
Reading time: 5 Minutes
January 9th, 2020
The brake pads on your car go and you're out $300. You have a cracked tooth and the dentist's bill comes to $500. There's a family emergency and you have to buy several interisland plane tickets on short notice.
Even with careful budgeting and planning, you never know when you'll hit a financial bump in the road. That's why it's important to save up an emergency fund, to handle unexpected expenses when they arise.
What is an emergency fund?
An emergency fund is a savings account that should be used for those truly unforeseen (and costly) events that can create a major financial burden. It's not a source of money to use for planned expenses like college tuition or a down payment on a home.
Sadly, an emergency fund has become elusive for many. According to the Federal Reserve, 40 percent of Americans say they would not be able to cover a $400 emergency.
A cash stash of four to six months of living expenses should get you through most of life's sudden emergencies. When calculating how much you should save, consider all the different things you would need to pay for during a time of hardship: rent, food, utilities, credit card bills, childcare. It all adds up pretty quickly.
Also consider your specific life situation: If you work in a specialized field where jobs are hard to find or you have a lot of medical expenses, a larger cash cushion makes sense.
Find a good home for your emergency savings
Unlike a retirement fund or college savings, a rainy day fund isn't meant to be invested with the goal of maximizing your interest returns. It should be a very liquid and accessible source of funds, so you can use the cash on very short notice without restrictions or red tape. The best place for an emergency fund is in a saving account at a bank. Because balances of up to $250,000 are federally insured, there's no risk of losing your money, and you'll be able to withdraw money right when you need it.
A savings account will allow your money to earn at least some interest, compared with, for example, a checking account you use on a daily basis. Make sure that you take into account any minimum balance requirements and/or monthly service fees when considering potential savings accounts. For example, federal regulations limit you to six convenient withdrawals per month, meaning you may be charged fees if you make additional withdrawals. If you anticipate needing to make frequent withdrawals from your account, it may be a better idea to set up a checking account and build your balance there.
Start building now
Saving up a fund of four to six months' worth of expenses may sound daunting to some. But don't let that big number discourage you. It's natural for it to take a while to amass a fully stocked emergency account. Until then, set smaller goals for yourself such as $500 or $1,000 to gain your saving confidence. Even these smaller sums can get you out of many financial jams and keep you out of debt.
To turbo boost your emergency savings, try these ideas:
Automate it: You know what they say, “Out of sight, out of mind." If you set up automatic monthly transfers from your checking to savings accounts, you'll never miss the money, and you won't have to remember to set aside funds every month. In fact, if you direct deposit your payroll, most employers will allow you to send your pay into multiple accounts, so the money you want to save can go straight into savings, skipping your checking account entirely.
Use your tax refund: Since money from a tax refund is often not built into your normal monthly budget, it can be easier to take that chunk of cash and save it, since you're not relying on it to pay bills. You can even opt to have your refund deposited directly into your savings account.
Sell your stuff: Look around. You probably have several hundred dollars' worth of items around your place that you could convert into emergency savings. And, bonus, your house will end up being a little neater and better organized.
Get a side hustle. Consider lining up gigs in your spare time, such as pet care or tutoring to get a cash infusion.
Of course an emergency fund won't prevent life's mishaps from happening in the first place. But, with a decent amount of cash at your disposal, at least you'll be able to deal with the emergency at hand more easily, instead of worrying how you'll survive financially on top of it.
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