An emergency fund can help you manage unexpected expenses without using a credit card or incurring personal debt.

“None of us, no matter our job, is immune to financial impacts,” Mikel Van Cleve, USAA advice director and CFP professional said. “Under the pandemic, we’ve seen major corporations close their doors, and small businesses that once were thriving fail.” Millions of Americans, who believed they were in secure recession proof positions, found themselves with jobs and regular paychecks.

Thus, Americans from every realm have witnessed firsthand the impact of unexpected black swan events can have on their livelihoods, hopes and dreams for the future.

“Emergencies—from a broken bone to a layoff—are a fact of life. When you’re faced with life’s unexpected events, you can be ready.”  Vanguard Investments

Even in the best of times, it might make sense to have a little extra money put aside for emergencies. A financial buffer can help if your car breaks down, you experience a loss of income, or you’re hit with a big medical bill. And having an emergency fund might also help you avoid tapping into savings and investments when an unexpected cost pops up.

An emergency fund is a cash reserve that’s specifically set aside for unplanned expenses or financial emergencies. Some common examples include car repairs, home repairs, medical bills, or a loss of income.

Oh, those unexpected expenses. Be prepared with an emergency fund that lets you borrow from yourself, no matter what happens.

— USAA (@USAA) March 24, 2021

Saving money isn’t always easy, but it’s likely to be less painful than the alternatives. A 2012 FINRA Investor Education Foundation National Financial Capability Study found that many of the people surveyed currently or recently:

• Had unpaid medical bills: 26%.
• Overdrew their checking account: 22%.
• Took a loan from their retirement account: 14%.
• Took a hardship withdrawal from their retirement account: 10%.
• Had more than one late mortgage payment: 13%.
• Filed for bankruptcy: 3.5%.

Furthermore, if you don’t have an emergency fund, you’re not alone. A 2019 Federal Reserve report found that 27% of Americans in 2018 would have a hard time covering an unexpected $400 expense. And 12% wouldn’t be able to pay for it at all.

How to Build an Emergency Fund

You might think that emergency funds are only for people who can set aside lots of extra cash each month. But even if money is tight, an emergency fund could help you feel more secure. Here are a few suggestions for building yours.

• Keep it separate. The Consumer Financial Protection Bureau (CFPB) recommends setting up a separate savings account for your emergency fund. This makes it accessible, but not so accessible that you’ll be tempted to dip into it.
• Start small if you need to. The Federal Trade Commission recommends saving even if you can only manage $10 each week or month. You might find it useful to set a regular schedule for your contributions and stick to it. It can be motivating and satisfying to watch the deposits add up, however small they start off.
• Pay yourself first. If you can, you might want to consider setting aside some of your income for savings before you spend it on anything else. You could even automatically transfer your chosen amount into a savings account each payday.
• Bank any extras. A tax refund, cash gift or raise at work could provide a good opportunity to kick-start an emergency fund or give it a big boost. Immediately setting that money aside can be a great way to grow your savings without dipping into your wallet.
• Say “yes” to the 52-Week Savings Step-Up Challenge. The premise is simple: This week, save $1; next week, save $2; in week 3, save $3. Continue adding a dollar a week for 52 weeks. A year from now, you’ll have saved $1,378 — and surpassed your first goal of $1,000.
• Schedule a monthly automatic draft that transfers money from your checking account to your savings account. This is the perfect solution if you look at your budget and know how much you can save. Just set it and forget it.

When to Use an Emergency Fund

After building an emergency fund, here are a few common situations when you might need to tap into your emergency savings.

• To protect your income. A financial buffer could help if anything threatens your ability to do your job—for example, if your car breaks down and you can’t get to work any other way, or you need a new piece of equipment.
• To replace your income. If your job is downsized or cut, your emergency fund could help you pay rent, buy food and cover other necessary expenses until you can find another source of income.
• To cover medical expenses. Using your emergency fund is a no-brainer if your doctor recommends treatment or medication for a health issue.
• To maintain a habitable living environment. Damage to your home, like a leaky roof, could cause more costly issues down the line if it’s not taken care of as soon as possible.

Remember, everyone’s situation is different, and you might have multiple ways to respond to a financial emergency. If you’ve been laid off and you’re struggling to pay bills, the CFPB recommends reaching out to your lenders directly. And it might be a good idea to seek the advice of a qualified financial adviser.

Bottomline

Whether you’re considering putting your money in a savings account, checking account, certificate of deposit, money market deposit account, money market mutual fund, bond or equity investment, real estate, or some other form of investment, weigh the following pros and cons:

• How liquid are the funds? In other words, can you immediately withdraw your money if you need it?
• Are there any fees or limitations to accessing the funds?
• If you access your funds, is there a risk of loss of principal?

In many cases, FDIC-insured savings accounts or money market deposit accounts are preferable options because your money is more easily accessible. Plus, it’s not subject to market fluctuations.

References:

1. https://www.federalreserve.gov/publications/2019-economic-well-being-of-us-households-in-2018-dealing-with-unexpected-expenses.htm
2. https://www.consumerfinance.gov/start-small-save-up/start-saving/an-essential-guide-to-building-an-emergency-fund/
3. https://www.consumer.ftc.gov/articles/0498-its-never-too-early-or-too-late-save
4. https://www.usaa.com/inet/wc/advice-finances-emergencyfund