It’s not a matter of if an unexpected emergency will happen, but when.
Whether it’s an emergency trip to the vet, car repair, or a job loss, an emergency fund can save you big time.
We’re going over everything you need to know about emergency funds so you can start your own and gain financial security.
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What is an emergency fund?
An emergency fund is a set amount of cash you have set aside in case of emergencies. You have peace of mind with an emergency fund because you know you will have everything covered financially in case anything happens.
How much money should I have in my emergency fund?
Some experts recommend having $1,000 saved as a starter emergency fund. That’s a great idea, but the main goal should be 6 months of living expenses.
At the time of this writing (March 2020), there is a lot of chaos in the world and a high unemployment rate. An emergency fund of 6 months’ living expenses would provide comfort for unemployed people and give you enough time to search for a new job.
Living expenses include things you need to spend on in order to live, such as rent/mortgage, electricity, internet, cell phone, groceries, insurance, etc. Living expenses do NOT include things like clothes, unnecessary subscriptions, entertainment, new toys like bikes, etc.
If a real emergency happened like losing a job, you would only need the bare minimum each month to live because you would not be spending money on clothes or entertainment.
Real-life example: My current monthly living expenses (not including fun money) equal about $1,400. $1,400 x 6 months = $8,400. My emergency fund should be $8,400. I want to create an extra safety net, so my emergency fund goal is $12,000.
How much you save is ultimately up to you and unique to your situation, but I highly recommend saving at least 6 months of living expenses.
When should I use my emergency fund?
You should only use your emergency fund in real emergencies like:
- Job loss
- An unexpected trip to the vet
- Medical emergency
- Car or house repairs
Your emergency fund is NOT for clothes shopping or a bike you decided you really want. You need to be very clear on what your emergency fund is for.
Where should I park my emergency fund?
Your emergency fund needs to be accessible at a moment’s notice. It’s also beneficial to park your emergency fund in a place that is going to grow some money without risk.
A high-yield savings account is a great place to park an emergency fund because they offer higher APY on savings accounts and usually have zero fees.
I park my emergency fund in an Ally savings account that currently grows at 1.60%. I used to have my savings in a regular local bank account that grew at .003 or something ridiculous like that. It made pennies each year.
Park your emergency fund in a high-yield saving account like Ally, Betterment, Marcus by Goldman Sachs, or CIT Bank. You have many options, so do your research on high-yield savings accounts and see which best suits you.
How to create an emergency fund
1. Save 1-month living expenses
Saving 6 months of living expenses may sound overwhelming at first, which is why creating small goals helps.
Aim to save 1-month living expenses to get started. How much do you spend in 1 month in order to live? Remember, you only want to count necessary expenses like rent/mortgage, electricity, internet, cell phone, insurance, etc.
Write down your numbers for necessary expenses and add them together. What’s the amount? This amount will be your first goal to hit.
P.S. If you don’t follow a budget yet, now is the time to create one. You can use my 8-step guide to creating a budget here.
2. Pay off certain debt
Once you hit your goal of saving 1-months living expenses, now is a great time to pay off certain debt like high-interest credit cards.
If you have credit card debt, you’re most likely paying a lot of money just for interest. Most credit cards carry a 20% interest rate.
For example, if your credit card’s interest rate is 20% and you carry a $500 balance, you’d owe about $100 in balance in interest alone annually. If you carry a much higher credit card balance and only pay the minimum each month, you’re likely paying hundreds of dollars in interest alone, barely scraping at the principal owed.
This is why it’s important to pay off high-interest debt as soon as you can. Once you pay off your credit card and other high-interest debt, it’s time to move to the next step.
Related: 30 Ways To Save More Money
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3. Create an emergency fund goal
Goals make things exciting and motivating. Goals also keep you in check to make sure you’re making progress.
Your emergency fund goals can look something like this:
Goal 1: By March, have 1-month living expenses saved.
Goal 2: By June, have 2 months living expenses saved.
Goal 3: By August, have 3 months living expenses saved.
Keep your goals written and in sight. Some people opt to put their emergency fund goals on their refrigerator. Or you can write your goals in the iPhone notes app (or download a notes app if you have an Android), take a screenshot of the goals, and place it as your screensaver.
Don’t forget to sign up for the free resource library and get access to free printables that will help you pay off debt and save for your emergency fund.
4. Pay off debt and save money
Once you’ve paid off high-interest credit card debt (if you have any), now is a great time to create a plan to pay off debt and save money for your emergency fund at the same time.
You may decide to split your extra money equally between paying off debt and saving for your emergency fund. This really depends on your situation and your goals. I would prioritize paying off certain debt first (student loans, auto loans, etc.) and treat your mortgage like a regular living expense instead of debt at this time.
Some people decide to pay off all debt before fully funding a 6-month emergency fund, while others decide to play it safe and have 6 months of living expenses saved before paying off all debt. I recommend the latter because emergencies happen at any time. Better safe than sorry.
Related: 50+ Ways To Make Money
5. Make saving automatic
An easy way to save for your emergency fund is by making saving automatic. You can do this depending on your banks options. Contact your bank by phone or in-person to see if this is an option by asking if they have automatic transfers available.
Digit is a great idea if you need help saving money without thinking about it. Digit analyzes your spending and automatically saves the perfect amount. I used it for a while when I needed help saving money. It’s actually a pretty cool app, so I recommend checking it out here.
Setting up an automatic transfer to your savings account makes savings easy.
- Always make a goal to contribute to your 401(k) up to employer match (that’s free money!)
- Make sure you use and follow a budget in order to maximize savings
- Put any extra cash into your savings if you have no debt (ex. tax refunds, stimulus checks, etc.)
An emergency fund is not optional. You need an emergency fund, so get started today if you do not have it already.
Do you have an emergency fund? How much do you have saved?
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