I am sure you’ve heard a million times before that you need to have an emergency fund. Life happens, and bad times comes unexpectedly bringing chaos to our finances.
Unfortunately, most people are not prepared financially and couldn’t afford to pay for unexpected. So, they go into debt by using credit cards, taking a personal loan or even taken money from their 401(k)s or IRA to cover the bill.
Life is full of unexpected surprises, many of which cost money.
Bad stuff always seems to happen at the worst time in life. If you have money to take care of these things, then you’ll have a lower risk of going into debt.
But if you don’t have any savings for emergencies, then more than likely, you’re going to have a hard time. That’s why we need to put money aside for these financial emergencies.
What is an emergency fund?
An emergency fund is a chunk of money set aside specifically for the unexpected things life throws your way.
An emergency fund is a cushion of protection against the unknown – job loss, the death of a loved one, unexpected medical bill or even home repair.
An emergency fund brings stability and calms to your financial life. Instead of panicking at every little unexpected expense, you’ have a small pot of money at hand, ready for use.
How much to save in an emergency fund?
Decide how much you would like to save for unexpected emergencies.
There are a lot of opinions out there how much money you should put into an emergency fund. I’ve seen people recommend saving anywhere from $1,000 to three to six months of living expenses. Some recommendations are up to two years of living expenses.
Honestly, I don’t think there is a magic number. Everybody’s income and financial situation are so different. The only opinion it matters is yours.
Ask yourself how much you would need to have tucked away to feel secure and try to save that money in your emergency fund.
If you can afford to have six months’ worth of living expenses saved in your emergency fund, then go for it.
If you cannot, then you’ll need to start with smaller money and build it up over time. If you don’t have an emergency fund at all, then why not start with a goal of $100 or $1,000? Then keep going until you have an emergency fund to a number that you feel comfortable with.
There is nothing wrong with taking baby steps to reach your financial goal. Everyone needs to start somewhere.
For many years Roman and I never had a designated “emergency fund”. We had savings and used it for any occasion including as an emergency fund. We tried to keep in our savings/ emergency fund account around six months of living expenses. It varied from $20,000 to $30,000. Once we draw down this account below $10,000 and had to re-built it again to the comfort level.
After staring this blog, I decided that we need to have a separate emergency fund, just for emergencies like medical bills, car and house repairs.
I have to tell you, it feels great! Our goal is to build it up to $40,000 in 2019. We will keep it untouched unless there is an emergency.
I like the idea of separating savings from emergencies for better control over our finances. With no separate account for emergencies, we were dipping into our savings for every crisis. I have noticed that our savings were not actually growing.
When you have a separate emergency fund to handle unexpected expenses, then you will no longer need to dip into your savings to cover these bills.
How to start an emergency fund?
To build your emergency fund, you need to start stashing away portion of your paycheck.
Decide how much cash you want to save in the fund.
As I mentioned before, there is no perfect number for how much you should stash away. A good benchmark is about three to six month’s of your living expenses
An easy way to calculate this amount is to make a list of all your basic monthly expenses:
- mortgage or rent
- utilities
- transportation
- insurance
- groceries
Then, total your monthly expenses, and multiply by the number of months.
For example, if you need $4,000 a month to cover your basic needs, then you’ll need to have $12,000 in your emergency fund.
$4,000 x 3 = $12,000
$4,000 x 6 = $24,000
The money saved in an emergency fund will give you a breathing room if you suddenly lose a job while trying to pay for unexpected doctor bill, car or house repairs.
As you get better at saving, probably you will start working toward accumulating 12 months of living expenses in a savings account.
$4,000 x 12 = $48,000
If you work in a career that has high turnover, or afraid of the potential downside of your company, it’s a good idea to double the money saved in your emergency fund.
How to build an emergency fund?
There is a challenge for most of us to build an emergency fund. Very often there is no money left at the end of the month. Saving money is a hard task no matter how much you make. There is always one more payment to make or unexpected bill to cover.
As women, we are very protective of our families.
By creating a financial cushion in the shape of the emergency fund will help you to fill save and comfortable when bad times come to your life.
Here are 8 simple steps to help you get started:
Step 1. To build an emergency fund you need to set mini-goals and work towards them. it takes time to accumulate enough funds in your account.
Step 2. Pay yourself first. Try to set aside 10 percent of your paycheck to go towards savings.
Step 3. Set an automatic deposit to an emergency fund account. It will be paid out of your paycheck and you will not even notice it.
Step 4. Set up a plan to pay off your debt. Add the extra money to the minimum payments every month.
Step 5. After all debt is paid off, add more money to your emergency fund.
Step 6. Control spending and leave your credit card at home. Its always easier to pay for everything with credit card. Bring only cash if you go shopping. Once the cash is gone, you can go home knowing that you didn’t go over the budget.
Step 7. Once your emergency fund starts growing, don’t over-use or deplete it to the point when you need to start all over again.
Step 8. Change your mindset. Think about savings as a financial cushion or smart gift to yourself.
How to Start and Build an Emergency Fund
Where to keep your emergency cash fund?
Where should you keep your emergency cash reserves?
You want your emergency money to be easily available. Most experts recommend keeping it in safe and accessible accounts, like:
- Bank savings account
- Money market account
- Short-term Certificates of Deposit (CDs)
- Roth IRA account
1. Bank savings account
In my opinion, it is one of the easiest places to keep your emergency fund.
The deposits held in this account are FDIC protected against the bank failure. You can get quick access to your money whenever you need it.
Most online savings accounts allow you to transfer the money you need within minutes.
If you want to earn some interest on your money, try to open a high-yield savings account.
2. Money market account
You can open money market account online or at a local bank and manage it through web-based account management. Your funds can be withdrawn at any time and you earn some interest on it.
However, remember about money market account’s fees that could chip away at your returns.
3. Certificates of Deposit (CD’s)
A Certificate of Deposit usually pays more in interest than an ordinary bank savings account.
CD’s offer a fixed rate of return (or gain on your money) for a specific time frame. Since your rate of return is guaranteed, opening a CD could be a good idea to earn extra interest on your emergency fund money.
On the other hand, you will have to pay a penalty if you want to close your CD early. It ties your money up for a certain period, so it’s a good idea to open a short-term CD account.
When you put money into a CD, you’re agreeing to leave it there typically from three months to five years. Decide for yourself what works the best for your financial situation.
4. Roth IRA account
I have heard many times that people advocate for using a Roth IRA money as an emergency fund. It might work for many people.
But I want to highlight the number of reasons why using your Roth IRA as an emergency fund is a bad idea:
- There are penalties on early withdrawals. The topic on penalties is complicated and it’s better to consult a tax professional or do research on IRS rules.
- Roth IRA account is set up mostly for retirement savings. It’s funded with limited contributions of $5,500 and $6,500 if you are 50 years or older – in 2018. In 2019 and 2020 is $6,000 (people age 50 or older can add $1,000). The money grows and accumulates slowly to provide an income in retirement.
- If you want to use it as an emergency fund it will be hard to sell your investments within 24-hours. And if it’s a recession you might sell your investments at a loss.
Where you keep your emergency money as important as building it.
The first part of a good emergency fund is liquidity. You need to get access to your fund within a few hours.
The second part is safety. It can’t be tied up in an investment that goes up and down in the short run (like stocks).
We keep our emergency fund in an online account Capital One 360 (formerly ING). It’s very easy to withdraw money in case of an emergency. And we earn more interest than the bank savings account.
Final thoughts
We all know that emergencies do happen. And being prepared for it can make all the difference between weathering the storm or being overwhelmed.
Building an emergency fund is possible at any income level. If you don’t have an emergency fund yet, start building it today. Everybody needs one.
Before spending or moving money around, start by setting up an emergency fund. In the case of job loss, medical emergency or any other personal crisis, you’ll want to know that you have a protection from a small disaster.
You’ll want to know that you have enough money to carry your family through to safety.
How are you saving for emergencies? Do you have a separate emergency fund?
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