Emergency Fund: What It Is and Why You Need It
Updated: July 5, 2021
Whether you call it a rainy day fund or an emergency fund, you’ll likely agree that having money set aside to cover unforeseen expenses is a good idea. Emergencies have a way of sneaking up on you without much if any notice. But having such a fund can be a godsend since you’ll be able to handle emergencies. Unfortunately, many Americans find themselves ill-prepared to cover unforeseen expenses. A Bankrate.com survey, for instance, shows that a mere 39% of Americans claim they can handle an unexpected expense of $1,000.
Do you want to learn about emergency funds, why it’s best to build one, how much you should save, and how you can get started on one? You’ll find the answers you seek below.
What’s an Emergency Fund Anyhow?
This is a term used to refer to a cash reserve that is placed in an account. It is typically left untouched until there’s an emergency situation that calls for funds. The types of emergencies a fund typically covers include the following:
- Medical expenses
- Fixing or replacing appliances
- Car repairs
- Job loss
So you can say that your emergency fund is reserved for unplanned or unexpected expenses that are not part of your regular budget.
When you set it up, you will be able to avoid accessing other options like high-interest debt options like payday loans, unsecured loans, or credit cards. You’ll also be able to steer clear of drawing from your retirement savings.
8 Primary Reasons to Start an Emergency Fund
There are many good reasons to have one. For instance, your air conditioner might break down during a heatwave, your pet might require life-saving surgery, your car’s transmission might give up the ghost, or you might have to leave town to tend to a family emergency. These types of situations can be stressful enough as they are. But if you don’t have the funds available to take care of these emergencies, you will encounter even more stress.
Check out these 8 reasons why you most certainly need such a fund if you don’t already have one.
#1. You Want to Clear Your Debt
You’ll certainly want an emergency fund if your goal is to eliminate your debt. With an emergency fund in place, you will be able to enjoy the type of financial flexibility that keeps you from sinking into further debt.
#2. You Have Recently Started to Budget
Have you recently started creating monthly budgets? If so, an emergency fund can be beneficial to you as you get accustomed to budgeting. The reason is that some budgeting newbies leave out some necessary expenses. If this describes you, your emergency fund can serve as an extra layer of security.
#3. You Are in a Single-Income Home
If you’re in a single-income household, an emergency fund takes on even more importance. With an emergency fund in place, your family will be protected should the breadwinner ever lose his or her job, or if this person ever has to take sick leave.
#4. You Are Your Own Boss
If you are an independent contractor or are otherwise self-employed, you will definitely need the security of an emergency fund. Sometimes being your own boss means you can’t get access to unemployment benefits. This will make it all the more critical for you to start an emergency fund.
#5. You Own a Residence
Do you own your own residence? If so, you need an emergency fund in order to deal with possible unexpected expenses such as your air conditioner, furnace, plumbing, or other things.
#6. Your Family Live Far Away from You
If you live a far distance away from your loved ones, you will want to have some money put away in the event that there’s an emergency that requires that you travel. Without an emergency fund, such situations can be extremely stressful.
#7. You Have Health Issues
If you have serious health issues, you might use up your entire deductible every year. But since extra expenses over your maxed-out deductible can really add up over time, you’ll want to have an emergency fund just in case. This will help you to handle any unexpected costs.
#8. You Want to Invest or Save Money
It’s always a good idea to save your money and to invest your money. With an emergency fund, you’ll have funds available should something unexpected occur. This means you won’t have to withdraw money from your savings accounts or investment accounts.
How Much Should You Put in Your Emergency Fund?
The answer to this question depends on different factors such as your income, debts, and lifestyle. But your emergency fund will likely be at a suitable level if you have between three months and six months worth of living expenses. This tally should be sufficient to help you deal with any unexpected events that may arise from time to time.
If you want to start building an emergency fund but have limited means to do so, you can start by trying to save about 2% of your salary into a separate account. As you continue to do this – and to increase the amount you save when you can – you will be able to build an emergency fund. Every little bit helps, so start small and then ramp up from there.
Where Should You Keep Your Emergency Fund
- It’s important to place your emergency fund in an account that you can easily access in the event of an emergency. This is why an ideal option for your emergency fund is a high-interest savings account. Keep this account separate from the financial institution you normally use. This will provide protection against dipping into the account for non-emergency things. An emergency situation can materialize without a moment’s notice. So you won’t want to place your emergency fund in a long-term investment fund that you can access readily.
- It’s a good idea to put your funds into a high-yield savings account. You’ll earn some interest, and the money will be easily accessible when needed.
Here’s How to Start Your Emergency Fund
Create a Budget and Figure Out How You Can Start Saving
When you’re creating a budget, it’s critical that you know exactly where your resources are going. This will help you to know, for instance, where you can cut back on spending. That’s why budgeting is so important. You’ll know how much money you’re bringing in, how much you’re spending, and how much you’re saving. Depending on your circumstances, you’ll be able to make changes. Some people find it easier to budget with a budgeting app. Try out one or several of them to see if this is something that will work for you.
Figure Out Your Emergency Fund Tally
One of the reasons a budget is a good idea is that you’ll be able to figure out a realistic emergency fund total by referencing your budget. By so doing, you’ll easily be able to figure out how much money you typically require for your living expenses.
Make Regular Contributions
Figure out a system for making regular contributions to your emergency fund. One of the easiest ways is to set up an automatic transfer process at your bank. You’ll be able to choose the amount and the frequency such as once a month, once every two weeks, or even once per week. When you go this route, you’ll find that it’s easier to save regularly.
Check Out How You’re Doing Regularly
Keep on top of things by regularly monitoring your progress. This might mean simply checking how you’re doing once or twice a month. If you do online banking, checking out balances can be easy since you can do so via an app on your phone.
Give Yourself a Pat on the Back
If you’re making good progress, take the time to give yourself a pat on the back. You can do this by treating yourself to something you want. Just make sure you do it in a financially responsible way.
Continue to Save – Even After You Accomplish Your Goal
After you’ve reached your emergency fund savings goal, don’t stop there! While you’ll initially want to save an amount equaling between three months and six months of expenses, you’ll want to keep on building when you achieve this goal. The more money you have saved in your emergency fund, the more financial flexibility you’ll have in the event of an emergency.
It’s important to be ready in the event that the unexpected happens – and it will happen from time to time. Having an emergency fund will help you to get through these unexpected events in a way that doesn’t leave you financially broken. You’ll have greater peace of mind and less stress if you put money away for a rainy day. So if you haven’t already started one, get cracking on building up an emergency fund.