How to Build an Emergency Fund
Financial surprises can lift your spirits. An unexpected federal tax refund, finding a $20 bill in a shirt pocket on laundry day, or receiving an instant rebate at checkout can put a smile on your face. But, when a water pipe suddenly bursts or an A/C unit stops blowing cold air on the hottest day of the year, the resulting financial surprise can quickly dampen your mood.
An emergency fund can help you maintain control of your finances when you’re blindsided by an unwelcome financial expense.
How much should you have in your emergency fund?
An emergency fund should contain enough money to cover three to six months worth of living expenses. It takes around five months to secure a new job according to recent Bureau of Labor Statistics data. If you lose your job, a six-month emergency fund can help bring calm to the situation. Some financial experts recommend saving nine to twelve months of living expenses to account for variances in geographic location and industry.
How do I establish an emergency fund?
The first step to establishing an emergency fund is to set a savings goal. If saving six months worth of living expenses seems overwhelming, break down your goal and focus on putting aside enough cash to cover one month of expenses. Even saving $500 over the next 12 months can move you in the right direction.
Once you decide on an initial savings goal, open a dedicated account that earns interest. Set automatic deposits from your payroll check or transfers from your checking account into the account to remove the temptation to spend the cash on frivolous purchases.
Use different accounts to save for other financial goals such as trips, retirement, or college expenses. Keeping your accounts separate helps ensure the money will be there when you need it.
If you mix your emergency savings and other credit union accounts, it will be easier to spend the money on non-emergency purchases.
Focus on building your fund quickly. The sooner you start an emergency fund, the sooner you can focus on other financial goals. Trim or eliminate unnecessary expenses while working on building your emergency savings. Tax refunds or pay bonuses are another way to grow your account quickly. Deposit the extra money into your emergency savings account.
Treat the emergency savings account as your financial insurance policy that earns interest. Only make withdrawals if you have a real financial emergency.
What expenses should be paid by an emergency fund?
Since everyone’s budget is different, the exact expenses that an emergency fund will cover will differ from household to household. The total costs can vary greatly. For example, someone who is debt-free and rents their home might have lower expenses than someone with student loan debt and a mortgage payment.
Everyday household expenses covered by an emergency fund during periods of unemployment include:
- Insurance (renter’s, mortgage, car, etc.)
- Credit card payments
- Car Gas
Review your monthly budget to determine the costs the fund will cover.
Common household expenses covered by an emergency fund while employed include unexpected home and car repairs, medical bills, and urgent pet care.
An emergency fund can help you stay on track to achieving your financial goals. When life’s unexpected situations occur, use your cash reserve to prevent it from turning into a significant financial setback.