Building An Emergency Fund: Why You Need One & How To Fund It

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Life happens all the time and it's hard to predict when or how surprises will arrive. Despite this fact, only 41% of Americans would be able to cover a $1,000 emergency with savings.

It could be that your income is cut or you lose your job and you are unable to find a new job as quickly as you planned. As a result, you may struggle to pay your bills. Or it could be that your car gets a flat tire, your water heater breaks or you need to buy an emergency plane ticket.

All of these are situations in which having an emergency fund can make all the difference. And given the unpredictability of life, it's very important to prioritize your emergency savings.

So what is an emergency fund and why is it important?

As the name indicates, your emergency fund, also known as emergency savings, is to help you weather unplanned life circumstances and emergencies. Having a stash of cash to fall back on when "life happens" means you won't have to rely on credit or rack up debt in order to resolve your situation.

It's the difference between having your car unexpectedly break down and leveraging cash you had already put aside for this exact purpose versus maxing out a credit card and figuring out how to pay for it later.

The latter scenario means an additional or higher credit card payment, more debt, and more money woes to worry about. And more importantly, you are now further away from your financial goals. This can be a major demotivator.

So essentially, you can think of your emergency fund as a form of insurance. Your own self created insurance with its main focus being to help you keep your financial goals intact.

But how an emergency fund is different from a sinking fund?

While your emergency fund acts as money to bail you out of unplanned life circumstances, a sinking fund is typically used for planned upcoming one time or irregular expenses like routine car maintenance or vacation savings for example.

How much emergency fund savings should you have?

Ideally, your goal should be to have 3-6 months of your essential living expenses in emergency savings.

Before you think this is unattainable, it's important to know that this is referring to your "basic living expenses". Essentially, how much do you need at a minimum to pay for your food, housing, core utilities, and transportation? Is that number sounding more attainable?

The thing is, when everything is nice and rosy in our lives, we tend to get comfortable with spending money on  "nice to have" things. However, your emergency savings really focuses on your "must-haves" which are essential to your life and survival.

Keep in mind that, your emergency fund might need to be broader than just your basic living expenses. It's all about recognizing what might come up and accommodating for that as you build your fund up.

For instance, if you are driving a 10-year-old car, it's more than likely going to need a major repair soon. So you'll want to build the cost of that potential repair outside of a routine service into your savings plan.

By having a plan to save in place, what could potentially be emergencies are now mere inconveniences.

That being said, a good first milestone to set is to save $1,000. This can cover most basic emergencies and is a good amount to have if you need to focus on other pressing financial goals like paying down high-interest debt.

How much should I have in emergency savings if I'm single vs. if I'm married?

If you are single, the more you have saved the better, so setting a goal of at least 6 months would be wise. This is simply because as a single person, you might not have anyone else to fall back on for financial support.

If you are married or in a relationship where you have a second income to fall back on, then you can start with 3 months as a goal and raise it 6 months once you reach 3 months of savings.

3 months because there are two incomes and it is less likely that you would both be out of a job for the same amount of time, for example.

I will, however, stress that the more you can save for emergencies, the better. 12 months of savings would be incredible to have especially during times of economic uncertainty like a recession for instance.

So how do you save that much money for emergencies?

Putting away 3 to 6 months of income for emergencies sounds like a lot but if you start with saving a little then you can save over time until you eventually reach your goal. The key here is to build your savings into your budget until you reach your emergency fund goal.

Remember, the amount of money you are saving is to cover 3 to 6 months of your basic living expenses so your housing, your food, and your transportation NOT your non-essentials and nice to have.

If an emergency comes up, you should leverage your emergency fund and then plan to replenish it later. The best way to save and meet your emergency fund goal is to include a category for emergency savings as part of your monthly budget. You can set up this amount to automatically get transferred to an account set up strictly for your emergency savings.

Where should you keep your emergency savings?

Your emergency fund should be easily accessible and liquid. This way you can get to it when you need it without having to wait or take a liquidation hit. Keeping that in mind, don't tie your savings up in the stock market or in real estate. An interest-bearing savings account or a certificate of deposit are good places to store your emergency money.

Tempted to spend your emergency savings? Consider setting up automatic deposits to a bank account at a different bank not connected to your main checking account. Also, skip the checks and debit card. Make it as easy as possible to avoid temptation.

The best savings account for your emergency fund

As mentioned above, you want to be able to access your emergency fund when you need it. However, you don't want it so accessible that it's easy for you to spend it. Online savings accounts are a great option. And so when it comes to the best savings account for your emergency fund, here are our favorite online accounts:

  • Chime: With Chime, you get an FDIC insured deposit account that can be managed entirely from your smartphone, plus a savings account that helps you save money automatically without thinking about it. There are also no fees ever. No overdraft. No minimum balance. No monthly service fees. No foreign transaction fees. No transfer fees. We are huge fans.
  • Credit Karma high yield savings: You probably already know Credit Karma as they are a well known, reputable, and highly reviewed credit monitoring company. Well, they also have a pretty awesome Credit Karma high yield savings account and your account is FDIC insured up to $5 million.

In closing

Having an emergency fund is essential and should be part of everyone's overall financial plans. The last thing you want is to be set back financially by not being prepared to handle things when life happens.

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