Emergencies—from a vehicle breakdown to a layoff—are a fact of life. When you’re faced with life’s unexpected events, you can be ready.
When things are going well financially and monthly expenses are being paid, emergency savings can seem unimportant. Yet, emergencies are unpredictable and can quickly derail your financial stability. And, a recent FINRA Study finds that 56% of people in the United States don’t have a rainy day fund that would cover 3 months of expenses.(1)
A sudden illness or accident, unexpected job loss, or even a surprise home or car repair can devastate your family’s day-to-day cash flow if you aren’t prepared. While emergencies can’t always be avoided, having an emergency fund can take some of the financial sting out of dealing with these unexpected events.
Being prepared for the unexpected – ensuring you’ve done what you can to protect yourself and the ones you love – can reduce stress and provide a good feeling. Many people at some time in life find they need to dip into savings during a rough patch, so make an effort to open an emergency savings account and try to make deposits on a regular basis.
An emergency fund are savings used to cover or offset the expense of an unforeseen situation. It shouldn’t be considered a nest egg or calculated as part of a long-term savings plan for college tuition, a new car, or a vacation. Instead, this fund serves as a safety net, only to be tapped when financial crises occur.
It is a good idea to work toward an emergency fund equal to 3 to 6 months of living expenses. But anything you can put away is better than being unprepared. Saving up emergency cash can be easier if your financial institution has an automatic payroll savings plan. These plans automatically transfer a designated amount of your salary each pay period – before you see your paycheck – directly into your account.
An emergency fund is useful for unexpected expenses, and to maintain personal financial liquidity and cash flow.
Reasons why emergency savings are important:
- Being prepared – Issues like car or home appliance repair are common occurrences. However, since they do not happen regularly, people often overlook these costs as they create a budget. By anticipating these costs, you can be prepared for these potentially expensive items.
- Avoiding debt – Emergency savings give you the option of dealing with the unexpected without having to take on debt. Without the cushion of emergency savings, you may be unable to pay regular bills if you face an emergency, and are more likely to take on debt.
- Having peace of mind – Having emergency savings will give you peace of mind. Even if you can’t save much, a little money set aside may make a big difference when you need it and reduce stress.
- Emergency savings give you the option of dealing with the unexpected without having to take on debt. Without the cushion of emergency savings, you may be unable to pay regular bills if you face an emergency, and are more likely to take on debt.
Thus, an emergency savings is a stash of money set aside to cover the financial surprises life throws your way. These unexpected events can be stressful and costly. Some of the top emergencies people face are:
- Job loss.
- Medical or dental emergency.
- Unexpected home repairs.
- Car troubles.
- Unplanned travel expenses.
Emergency funds create a financial buffer that can keep you afloat in a time of financial need without having to rely on credit cards or take out high-interest personal loans. It can be especially important to have an emergency fund if you have debt, because it can help you avoid borrowing more.
The right amount for you depends on your unique financial circumstances. Most experts believe you should have enough money in your emergency fund to cover at least 3 to 6 months’ worth of living expenses in case of an unexpected financial emergency. This account should be relatively liquid.
For your emergency or rainy day fund, you’ll want to choose savings or investments accounts that are:
- Safe from market risk. You want to know that your money will be there when you need it—especially in times of market or economic turbulence.
- Easy to access. This will ensure you’ll be able to take care of your emergency quickly
- Interest-bearing. The point of an emergency fund isn’t to make money, but don’t turn down the opportunity to earn interest on your savings.
If you lose your job, for instance, you could use the money to pay for necessities while you find a new one, or the funds could supplement your unemployment benefits.
Start small, but start.
Saving even small amounts such as $500 can get you out of many financial scrapes. Put something away now, and build your fund over time.
An emergency can strike at any time, having quick access is crucial. But the account should be separate from a bank account you use daily, so you’re not tempted to dip into your reserves.
Building an emergency fundCalculate the total that you want to save. To figure out how to add up your expenses for six months.
- Set a monthly savings goal. Get into the habit of saving regularly. One way to do this is by automatically transferring funds to your savings account each time you get paid.
- Keep the change. When you get $1 and $5 bills after breaking a $20, drop some in a jar at home. When the jar fills up, move it into your savings account.
- Move money into your savings account automatically. If your employer offers direct deposit, there’s a good chance they can help you break up your paycheck into multiple checking and savings accounts.
- If there’s no money left, cut expenses. See which parts of your monthly spending you can trim, so you’ll have cash left over to build your fund.
- Get supplemental income. If you have the time and willpower, get a side hustle or sell unused items from home to accumulate more money for your fund.
- Save your tax refund. Saving tax refund can be an easy way to boost your emergency stash. When you file your taxes, consider having your refund deposited directly into your emergency account.
- Assess and adjust contributions. Check in after a few months to see how much you’re saving, and adjust if you need to add more.
An emergency fund is for emergencies only. Usually it’s something that affects your health, your home or your ability to earn money.
What’s not an emergency?
- Holidays, birthdays and mental pick-me-ups for yourself or significant others.
- Vacations.
- The chance to get a great deal on something you don’t need.
- Expenses that aren’t surprises, such as car insurance.
When saving, draw a line between emergencies expenses and everything else. In fact, once you’ve hit a reasonable threshold of emergency savings, it’s a good idea to open multiple savings account for irregular but inevitable items such as car maintenance, vacations and clothing.
Everyone needs to save for the unexpected. Having something in reserve can mean the difference between weathering a short-term financial storm or going deep into debt. Emergency savings can help you handle unexpected events. With money set aside for emergencies like unexpected car repairs or sudden job loss, you can better take care of yourself and your family financially.
Building an emergency fund
Calculate the total that you want to save. To figure out how to add up your expenses for six months.
- Set a monthly savings goal. Get into the habit of saving regularly. One way to do this is by automatically transferring funds to your savings account each time you get paid.
- Keep the change. When you get $1 and $5 bills after breaking a $20, drop some in a jar at home. When the jar fills up, move it into your savings account.
- Move money into your savings account automatically. If your employer offers direct deposit, there’s a good chance they can help you break up your paycheck into multiple checking and savings accounts.
- If there’s no money left, cut expenses. See which parts of your monthly spending you can trim, so you’ll have cash left over to build your fund.
- Get supplemental income. If you have the time and willpower, get a side hustle or sell unused items from home to accumulate more money for your fund.
- Save your tax refund. Saving tax refund can be an easy way to boost your emergency stash. When you file your taxes, consider having your refund deposited directly into your emergency account.
- Assess and adjust contributions. Check in after a few months to see how much you’re saving, and adjust if you need to add more.
An emergency fund is for emergencies only. Usually it’s something that affects your health, your home or your ability to earn money.
What’s not an emergency?
- Holidays, birthdays and mental pick-me-ups for yourself or significant others.
- Vacations.
- The chance to get a great deal on something you don’t need.
- Expenses that aren’t surprises, such as car insurance.
When saving, draw a line between emergencies expenses and everything else. In fact, once you’ve hit a reasonable threshold of emergency savings, it’s a good idea to open multiple savings account for irregular but inevitable items such as car maintenance, vacations and clothing.
Sources:
- FINRA Investor Education Foundation National Financial Capability Study, 2012, pg. 13
- https://www.nerdwallet.com/blog/banking/savings/life-build-emergency-fund/
- https://www.thebalance.com/do-you-need-a-rainy-day-fund-and-an-emergency-fund-4178821
- Building Emergency Savings, UMBC