The Ultimate Guide To Emergency Funds (2021)
My employer stopped paying me, and it may have been the best thing that ever happened to my finances!
Of course, that’s not how I felt at the time.
It was a small company, my first “real” job out of college, and I was excited to be working in my chosen field. When the receptionist handed me my first paycheck, she also warned me to cash it quickly. But it wasn’t until the following morning that I really understood what she meant.
That’s when I found all my coworkers lined up to cash their paychecks too. Luckily for us, all the checks cleared that day. But it wasn’t long before my employer stopped handing out paychecks altogether.
At the time, I didn’t have an emergency fund. I remember feeling panic as I scrambled for work to pay my bills. I hated having no control, and I vowed that I would never be unprepared again.
In retrospect, this experience was one of the best financial lessons I ever received. It taught me the importance of having emergency savings and how much it affects other aspects of our lives. This is why I am so passionate about the subject.
In a way, your emergency fund is the foundation of your personal finances. In this guide, we’ll explore everything there is to know about emergency funds.
We will review why you should have one, how much you need, where to keep it, and how to use it. But, most importantly, we’ll discuss the steps you need to start building yours today.
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What Is An Emergency Fund?
An emergency fund is money that you set aside to deal with large, unexpected expenses. Think of it as a financial safety net for the curveballs in life.
Why Do I Need An Emergency Fund?
Sometimes called a “rainy day fund,” an emergency fund creates a financial buffer against unexpected events like a job loss, home repair, illness, or car repair. These are stressful events that cause havoc on a family’s finances.
With emergency savings, you avoid bad financial decisions that come with high interest, fees, and penalties. Options like payday loans, cash advances, and early retirement withdrawals may solve a short-term need but come with terrible long-term costs.
We all have bad days. When you add financial stress to the situation, it can become overwhelming. That’s when people make bad decisions. And then a bad day gets even worse.
By having an emergency fund, you empower yourself. When you have the money, you have options. And with options comes power. The result is that your emergency savings can quickly turn a crisis into an inconvenience.
Psychologically, it also lowers stress, builds confidence, and creates peace of mind. And this can spread into other areas of your life because your emergency money empowers you every day, not just the bad ones.
How Much Should Be In My Emergency Fund?
Most financial experts recommend keeping three to six months of expenses in an emergency fund. If that sounds like a lot, don’t feel discouraged. Even $500 can get you out of many financial jams. The key is setting a goal, making a savings plan, and building it up over time.
The first step is deciding how many months of expenses to save. Start by evaluating the financial risk in your life. The less stable you feel, the more emergency money you’ll want.
The easiest and fastest way to answer this question is with my How Much Should You Save In Your Emergency Fund quiz. This short seven-question quiz helps you find the right amount of emergency savings for your situation.
You can take the quiz using the button below.
How Much Should You Save In Your Emergency Fund? Take The Quiz To Find Out
If you prefer not to use my quiz, then ask yourself these questions:
- Does your family have only one income?
- Is anyone in your family working on commission, self-employed, or freelance?
- Do you feel like you work in an unstable job, company, or industry?
- Does anyone in your family have a significant medical issue?
- Do you own a home?
- Do you have an older car?
- Does your extended family live more than 100 miles away from you?
The more you answer yes, the more financial risk exists in your life. But, you can offset this risk with more emergency savings.
So, if your situation is pretty stable, then three months should be enough money. However, as the level of uncertainty increases, so should your savings.
More Risk = Save More Cash
What if you’re someone who prefers having extra money in your emergency fund? There’s nothing wrong with saving more. The right amount is whatever makes you feel comfortable.
You could save up to a year’s worth of expenses if you want. However, anything over that is probably better off in an investment account.
Where Should I Keep My Emergency Fund?
I recommend keeping your emergency fund in a high-yield savings or money market account. Both provide principal security but with a little better interest rate. However, the interest rate is actually less important than keeping the money separate, liquid, and accessible.
- Your emergency money should be in its own account. It makes accounting easy, and you won’t accidentally spend it.
- Your emergency savings should always be available. Think of it more like insurance than an investment. Investments can be volatile and difficult to liquidate. So, please resist the urge to invest it and keep it in a savings or money market account.
- Make sure your money is easily accessible when you need it. Look for an account with an ATM/debit card, checks, or the ability to transfer somewhere quickly that does.
- But Not Too Accessible
- Sometimes it’s helpful if your emergency fund isn’t too accessible. Consider keeping it in a different bank than the one you use to pay your bills. That way, your emergency money is out of sight and out of mind.
Where To Keep Your Emergency Money
How Do I Use My Emergency Fund?
Knowing how to use your emergency fund effectively in a crisis is the best way to maximize your resources. Emergencies happen, and sometimes you need to use your savings.
While you should never feel bad about using it, you also owe it to yourself to spend it carefully. Being deliberate with how and when you spend the money ensures it lasts as long as possible.
When Is It An Emergency?
So how do you define an “emergency?” Sometimes, a situation feels like an emergency in the moment but doesn’t really justify using your emergency savings. It’s also easy to see your emergency money as the answer any time you need extra cash.
However, you never know when another crisis might be waiting around the corner. So, it’s in your best interest to be conservative with your money.
That’s why I suggest you ask yourself these three questions anytime you consider using your emergency fund:
- Is it unexpected?
- The expense should be unplanned and unanticipated. If it isn’t, then it should be part of your regular budget or another savings plan.
- Is it necessary?
- The expense should be essential to your well-being.
- Is it urgent?
- Just because something is necessary doesn’t make it urgent. The expense should be something that simply can’t wait.
How To Define An "Emergency"
If you can’t answer yes to all three questions, it’s probably better to find another solution. Some examples of situations that fit these criteria are:
- Job loss
- Medical or dental emergency
- Unexpected home repair
- Car repair
- Travel expenses for a family emergency
How To Spend It
Once you’ve decided to use your emergency money, there are still ways to reduce the amount you spend.
- Reduce Household Expenses
- At the first sign of trouble, tighten your family’s budget as much as possible. Prioritize your most important expenses like food, utilities, rent/mortgage, and transportation. Put anything nonessential on hold. The more you cut your monthly costs, the more financial flexibility you create to handle the problem.
- Negotiate Costs
- Sometimes you can get a discount or extend the payment schedule (without incurring interest). This is especially true when you pay with cash.
- Earn Extra Money
- Look for opportunities to bring in extra money. Perhaps you can work some overtime, get a side gig, or sell stuff. The more you earn, the less you need from your emergency savings.
How To Manage Your Money During A Crisis
After The Emergency
Once the emergency is over and you are back on your feet, you’ll need to replenish your emergency fund. You don’t want to get caught without any emergency savings. So, go back into savings mode and rebuild it as fast as possible.
How Do I Build My Emergency Fund?
Creating a consistent savings plan is the fastest way to build an emergency fund. But the real key is your determination. If you can stay focused, then you will accomplish your goal.
To help you start saving, begin with these eight easy steps.
Creating a budget is technically outside the scope of this article. However, I thought it was important to mention it briefly since you will need to know some of your numbers for the next steps.
If you don’t already have a household budget, then this is the perfect time to create one. And it doesn’t need to be complicated. A simple list of your income and expenses is enough. Or, if you are interested, you can go in-depth with programs like Mint, Quicken, or Simplifi.
Either way, as long as you know your total monthly income and expenses, then you can start building emergency savings.
1. Set Your Goal
Before you get started building your emergency fund, you need to set your savings goal. Calculate this by multiplying your monthly expenses by the number of months you need. For most people, this will be somewhere between three and six months.
If your number is quite large, it may feel overwhelming. If that’s the case, start smaller. Set your first goal at $500 or $1000. Once you achieve that, increase it to one month of savings. Then, keep moving higher until you reach your ultimate goal.
If your monthly expenses are $4,000 and you want six months of expenses, you need to save $24,000.
2. Review Your Budget
Review your household budget for items to cut or trim. Keep in mind that these changes don’t have to be permanent. The more you squeeze out of your budget, the sooner you’ll reach your goal.
The other way to accelerate the process is with more income. When available, you can significantly boost your earnings by working overtime, freelance, or a second job.
However, these days you have so many more options for side gigs. Companies like Fiverr, Uber, Lyft, and Instacart offer you ways to make extra money on your schedule.
If you increase your income to $4,200 and reduce your monthly expenses to $3,700, you would have $500 available to save each month.
3. Move Existing Savings into Your Account
Kickstart the process by moving any existing savings into your emergency fund. Just subtract this amount from your savings goal to determine how much you still need.
If your goal is $24,000 and you have $4,000 in a savings account already, you’ll need to save $20,000.
4. Make Your Monthly Plan
Now that you’ve reviewed your budget and savings goal, it’s time to make a monthly plan. Using your budget, decide how much you can afford to save each month. Then use the result to calculate how many months it will take to achieve.
If you need an additional $20,000 and can save $500 per month, it will take 40 months to complete your plan.
5. Make It Automatic
Putting your plan on autopilot is the easiest way to stay on track. Set up an automatic transfer from your checking to your savings account. Or have some of your paychecks direct deposited into your savings account.
Both options are easy to set up, and either will keep you saving consistently. Plus, they both prevent you from accidentally spending the money elsewhere.
If you’ve determined that you can save $500 per month, set up a $500 recurring monthly transfer from your checking to your savings account.
6. Boost Your Savings With Unexpected Money
Take advantage of any unexpected money by depositing some or all of it into your emergency fund. Holiday gifts, work bonuses, and tax refunds are all great opportunities to jump ahead in your savings plan.
In this hypothetical scenario, each $500 you receive unexpectedly will shave a month off your plan.
7. Track Your Progress
Keep tabs on your progress by regularly monitoring your savings. Whether it’s automated or manual, you can choose any method that works for you.
But consistently checking your account balance is your opportunity to be accountable and make corrections. Not to mention that watching your money grow can be a great source of encouragement.
8. Motivate Yourself
Maintaining your motivation throughout the process is hard. But it’s essential for success. Help yourself by constantly looking for ways to stay engaged.
Try starting with some of these ideas and see what works for you:
- Write down your goal
- Chart your progress and post it where you will see it every day
- Imagine what success looks like
- Make it a competition with your partner or a like-minded friend
- Celebrate your progress when you reach smaller milestones
Conclusion & Key Takeaways
An emergency fund is the cornerstone of financial preparedness. That’s why every family needs one. It’s like an emergency kit for your finances. And, just like an emergency kit, you’ll be happy you have it whenever you need it.
Together, we’ve looked at emergency funds from just about every angle. And while emergency funds may not solve every problem, they do make solving problems easier. So, now it’s time to get started building yours.
- An emergency fund is money you set aside as a financial buffer against unexpected events like a job loss, home repair, illness, or car repair.
- By having an emergency fund, you empower yourself, lower stress, build confidence, and create peace of mind.
- Save three to six months’ worth of expenses in your emergency fund. The less stable you feel, the more emergency money you’ll want.
- Keep your emergency fund somewhere separate, liquid, and accessible (but not too accessible) like a high-yield savings or money market account.
- Only use your emergency money when the situation is unexpected, necessary, and urgent.
- Maximize your resources during a crisis by reducing household expenses, negotiating costs, or earning extra money.
- Creating a consistent savings plan is the fastest way to build an emergency fund.
Did I miss anything? Feel free to post any thoughts or suggestions in the comments. For more helpful tips, check out some of my other articles in the links below.