Why You Need an Emergency Fund
What do car accidents, house fires, and layoffs all have in common?
They’re all unexpected, uncontrollable, and urgent life events that happen in our world every day. While you can’t predict or prevent these moments, you can prepare for them. Building an emergency savings account helps protect your financial well‑being when you need it most.
An emergency fund is a financial safety net that can help cover unexpected expenses without breaking your budget or taking on debt. Emergency savings should be kept separate from your other long-term savings goals and only used in case of an emergency. Having this fund in place will help prevent reliance on credit cards, personal loans, or payday lenders during financial emergencies. Consider these tips to help you build your emergency savings fund.
Budgeting for an Emergency Fund
According to Bankrate research, nearly half of Americans could not cover a $1,000 emergency expense if it arose. Setting aside cash for unexpected events is important for long-term stability and can also give you some peace of mind, considering how unexpected life can be.
A common rule of thumb is to save enough to cover at least three to six months of living expenses in an emergency savings fund. Self-employed individuals, freelancers, and single-income households may benefit from saving closer to six months or more. The amount of cash you should budget for emergency savings depends on your lifestyle, committed expenses, household size, and income.
How to Calculate Your Emergency Savings Goals
Here’s a simple way to determine how much emergency money you should aim to save and how much to put back each month.
Step 1: Calculate Your Monthly Essential Expenses
These expenses include your rent or mortgage payment, utilities, car payments, gas, groceries, phone bills, and any other required monthly payments. For this example, we’ll assume $2,000 a month in expenses.
Step 2: Pick the number of months you would like this emergency fund to cover
Although it’s often recommended to save enough to cover at least six months of expenses, we’ll use three months for this example. If your income is variable or commission based, consider choosing a longer coverage period.
Step 3: Set Your Savings Timeline
Decide how long you want to take to reach your emergency savings goals. This number will depend on the amount of money you can realistically save each month. For this example, let’s say that we want to reach our goal in three years. A realistic timeline helps improve consistency and reduces financial strain.
Step 4: Calculate Your Monthly Contribution
- First, multiply your monthly expenses by the number of months your emergency fund will cover.
- $2,000 * 3 = $6,000 needed in emergency funds
- Next, multiply the number of years you plan to save by 12 to determine the number of months you’ll need to fund the emergency account.
- 3 * 12 = 36 months to fund savings goal
- Finally, divide by the emergency savings goal by the number of months needed to determine your monthly contribution.
- $6,000 / 36 = $167 saved per month
In this example, you would need to save $167 each month for three years to build a $6,000 emergency fund. This doesn’t account for any interest accrued from your savings account.
Where to Stash Your Emergency Cash
Now that you know how much money you need to save to build up your emergency savings, you’ll want to decide where to save it. Opening a separate account can help reduce the temptation to dip into it for non-emergencies. Here are a few safe options for storing emergency money.
- Savings Account: This type of savings account allows for easy access to your money in case of an emergency and offers better interest rates than a typical checking account.*
- Money Market Account: A money market account is like a cross between a savings and a checking account. You can earn interest while still having access to funds through a debit card.**
- Certificates of Deposit (CDs): Another option is to place some of your emergency savings into a CD if you’re confident you won’t need immediate access to that money. You’ll get a guaranteed rate of return based on your initial deposit and term selected. You may also consider laddering CDs so they mature at different dates, giving you periodic access to your money. Use our Certificate of Deposit Calculator to help you save more money.
These options help keep your emergency fund separate and protected. If this fund ends up being used for recreational purchases, such as vacations or new cars, you will no longer be protecting your finances for emergencies.
Smart Emergency Savings Strategies
Depending on your situation, it may be difficult to set aside money into an emergency savings account. Here are a few strategies to help make it more manageable.
- Make savings automatic: Use direct deposit to automatically transfer a portion of your paycheck into your savings or money market account each month. Automation removes the temptation to skip contributions.
- Evaluate and reduce monthly expenses: Look at non-essential costs that can be substituted with less expensive alternatives or cut out completely. If you buy coffee every morning, try making coffee at home or taking advantage of free coffee at work. Review subscriptions that may be non-essential, try cooking more at home, and dine out less. Your emergency savings account will thank you.
- Sell unused items: If you haven’t used something for six months, consider selling it. There are a ton of free apps and websites now that help you sell unwanted items for cash. You could also have a good old-fashioned garage sale. Put the money you make into your emergency savings account.
- Consider an additional source of income: Have a talent that you could make money from, or have some extra time? Find ways to make more money by getting an odd job or secondary source of income .
- Re-calculate your budget each year: Expenses and circumstances are always changing, so make it an annual task to ensure you’re saving the right amount. Our How to Create a Simple Budget article can help make tracking your monthly budget easier than ever.
Why an Emergency Fund Improves Financial Well-Being
A fully funded emergency savings account gives you the ability to handle unexpected challenges calmly and with confidence. It can also help you avoid high-interest loans (like payday loans) or racking up credit card debt. This approach will enhance your lifestyle, both financially and emotionally, giving you peace of mind when you need it most.
For personalized guidance, contact a First American Bank representative to learn more about the best savings accounts for your emergency fund.
