Everyone needs an emergency fund to get through emergencies. Life happens when we least expect it, and if you don’t have the money set aside, it could cause serious financial issues.
But how much should you save for an emergency fund, and where should you keep it?
Keep reading to learn more.
Table of Contents [Hide]
- What is an Emergency Fund?
- Why do you Need an Emergency Fund?
- How Much Should You Save for an Emergency Fund?
- Steps to Determine How Much to Save for Emergency Fund
- Where Should you Put your Emergency Fund Money?
- When is it Okay to Use an Emergency Fund?
- Tips on How to Save an Emergency Fund
- Should you Borrow Money to Cover an Emergency?
- Final Thoughts
What is an Emergency Fund?
An emergency fund is money set aside for unexpected expenses. The funds shouldn’t be figured into any other savings, such as retirement, down payment for a house, or any other financial goals. It’s your ‘rainy day fund’ when things don’t go as expected.
Why do you Need an Emergency Fund?
An emergency fund prevents financial problems when things go awry. For example, if your car breaks down unexpectedly, it could cause financial issues if you live paycheck-to-paycheck. However, if you have money set aside, you can cover the expenses and still pay your bills on time.
How Much Should You Save for an Emergency Fund?
How much you should save for an emergency fund depends on your income and the peace of mind you want. Most people keep three to six months worth of expenses. So, for example, if your monthly expenses are $1,000, you’d aim to save $3,000 – $6,000.
However, some people save even more to have peace of mind. For instance, during the pandemic, three months of expenses saved wasn’t enough for many people who lost their jobs and could not replace them during that long period.
3 Steps to Determine How Much to Save for Emergency Fund
Consider these steps to determine how much you should save for an emergency fund.
1. Determine your Fixed Expenses
List your mandatory or fixed expenses. These are the expenses you must cover to live. Common examples include:
- Medical care
Think of any expenses you must pay to have the bare necessities. Don’t include things like money for entertainment, eating out, or unnecessary shopping.
2. Total your Monthly Expenses
Add up your monthly expenses to determine how much you need to save. Including a cushion to account for inflation or unexpected expenses during that time is a good idea.
Next, multiply that amount by six or however many months you would like to have saved in an emergency fund.
3. Revisit your Number Periodically
Every year or so, revisit your emergency fund amount. Determine if it’s still enough to cover your monthly expenses for at least a few months. Because expenses change (and often increase), ensuring you still have enough is a good idea.
Where Should you Put your Emergency Fund Money?
Where you keep your emergency fund money is essential. For example, putting it in your checking account is a bad idea. This is where you spend your money from, and you could easily spend the money you have saved for emergencies.
Instead, put it somewhere separate. Putting the money in a different bank is even a good idea. So, if you have your checking account at Chase, you may want to put your emergency fund savings account at Wells Fargo. These are just examples to show how to do it.
The key is not to have easy access to your emergency funds. If you keep the account at a bank that’s easily accessible or an account that’s linked to your spending account, it’s easy to transfer funds to cover an impulse purchase and deplete your savings account.
Some common places to put an emergency fund include:
- Savings account: Stick to online high-yield savings accounts to earn the most interest on your funds. You can find these accounts at many banks online, such as Ally and Discover. They pay much higher APYs than brick-and-mortar banks, and accessing your funds is harder.
- Money market accounts: If you have a little money already saved, you can open a money market account, which often pays even higher APYs than savings accounts. You may need an opening balance of $500 to $1,000, so you may need to wait until you have enough money saved.
- CDs: Certificates of Deposit are a great way to save money for a rainy day, but there’s a downside. They have maturity dates, and if you withdraw the funds beforehand, you may pay an early withdrawal penalty. If you choose a CD, look for a no-penalty CD that allows you to withdraw funds anytime.
When is it Okay to Use an Emergency Fund?
It’s important to set rules when you should and shouldn’t use your emergency fund. Write your rules down so you aren’t tempted to use the funds for other purposes.
Some people save emergency funds strictly for unemployment or health issues that make them unable to work. Others use the fund for unexpected expenses, such as:
- Car repairs
- House repairs
- Unexpected medical bills
- Other unexpected (but necessary) expenses
Tips on How to Save an Emergency Fund
So, how do you save an emergency fund? No matter how much money you make, here are some steps to get you started.
1. Make Saving an Emergency Fund Required
Make saving an emergency fund like a bill you must pay. Set up automatic transfers from your checking to your savings account each payday to ensure you always put money away for your emergency fund.
Your emergency fund should be a line item on your budget, one that is non-negotiable, like your rent or mortgage payment.
2. Cut Spending
Cut back on your spending if you create your budget and don’t see room to save for an emergency fund. First, decide how long you want to take to fill your emergency fund. At least aim to save $1,000 within a few months if possible, but choose what works best for you.
Next, decide which spending you can cut out while you save your emergency fund. Some common examples include:
- Unnecessary shopping
- Coffee shop stops
- Dining out
3. Trim Bills
After cutting out unnecessary spending, consider trying to trim your bills. It’s easier than most people think.
Review your monthly bills and determine which you can cut down. For example, you can shop around for lower internet and phone services. You may also ask credit card companies for a lower APR or cut out cable and instead pay for a much less expensive streaming service.
4. Revisit your Emergency Fund Savings
Check on your emergency fund savings often. Ensure you’re sticking to your plan and are saving enough money each month to reach your goal.
If you experience an emergency and use the funds, replenish them. If you’ve stopped saving for an emergency fund because you had enough saved, start the process again to ensure you have enough money to cover the next emergency.
Should you Borrow Money to Cover an Emergency?
If you haven’t saved enough money yet and have an emergency, you might wonder if borrowing money is acceptable.
While it’s not ideal, sometimes it’s the only option. The key is understanding the cost (interest), required repayment terms, and how it will affect your budget. A loan could complicate things if you’re already living paycheck-to-paycheck.
If you must borrow money, consider the following:
- Family or friends: Don’t be afraid to ask those close to you to help financially. If you have an emergency outside your control, they may be able and willing to help. You can set up a repayment plan to pay the funds back but don’t have to worry about excessive interest or other costs.
- Personal loan: You may qualify for an unsecured personal loan if you have good credit. Only borrow as much as you need for the emergency and repay it as quickly as possible to keep your costs low.
- Home equity loan: If you own a home and have equity in it, you may be able to borrow money from it. Home equity loans usually have low interest rates, but they increase your monthly obligations, so use caution.
Taking a cash advance from your credit card is rarely a good idea. Not only are the APRs high (even higher for cash advances), but most credit card companies charge a cash advance fee. This increases the cost of borrowing tremendously and creates a cycle of debt.
Make saving for an emergency fund a top priority in your budget. It should overtake any unnecessary spending so you can rest assured you have enough money to cover expenses when they come up when you least expect them.
How much you should save in an emergency fund depends on how much you make and how many months of expenses you want to cover to protect yourself. There’s no right or wrong way to save an emergency fund; the key is to save one to protect yourself.