How to Start an Emergency Fund

If you have been struggling to pay your bills and find yourself unable to cover an unexpected expense, then you may benefit from an emergency fund. Experts suggest you should have a liquid fund of at least three to six months of living expenses.

We all know that unexpected financial emergencies happen. We’ve all had them at one point or another. It can be an unexpected medical bill, a traffic accident, or even a broken refrigerator.

That’s why having an emergency fund is so important. It’s a financial safety net that meets unexpected expenses.

What is an Emergency Fund?

A financial emergency fund is a cash reserve that you set aside for unplanned expenses or financial emergencies. This can include car repairs, home repairs, medical bills, or even losing your job. 

Generally, emergency funds can be used for any type of bills or payments that are unplanned and not part of your routine monthly expenses and spending. 

Why You Need an Emergency Fund

Without savings, you might be left in the lurch financially. Any unexpected expense could set you back if you’re not careful. If you end up in debt because of it, it could seriously impact your life for years to come.  

In a financial emergency, individuals who have less money to help cushion the blow typically have to rely on credit cards or loans if they have no savings in the bank. This can lead to debt, which is generally harder to pay off. 

If your financial situation is shaky, you’re going to have a hard time recovering quickly if something bad happens. When unexpected financial shocks happen, some people turn to credit cards and loans to cover their costs. However, this only puts them in more debt, and they end up taking even longer to recover.

How Much Should You Have in Your Emergency Fund?

At first, start small and don’t focus on big numbers. Set a small, achievable goal like $500. When you’ve achieved that goal, keep growing it until you have enough to cover your expenses for a month. 

Ideally, it would be best to have enough money in your emergency fund to cover six months of expenses. This will help you avoid financial hardship if anything unexpected comes up.  

If you’re unsure how much money you need for six months of expenses, you can use this calculator to estimate it for you. Also, you may want to save more if you have an unpredictable income or are the only one supporting your family. 

How to Start an Emergency Fund

There are different ways to get your emergency fund started. These strategies cover a range of situations, including if you have a limited ability to save or if your pay tends to fluctuate. But you can follow these basic steps.

• Figure Out How Much You Need

  
  

The first thing you’ll need to do is to decide how much you will need in total for your emergency fund. This means you’ll need to add up all of your monthly expenses and multiply that number by six since you should have enough savings to cover six months of expenses. Be sure to include all of your bills, no matter how small.

• Set Your Goal 

  
  

As mentioned earlier, when you first start, don’t look at the big picture. Start with a small goal first. Reaching your first goal will keep you motivated and wanting to keep going. Set your second goal higher and then higher again. By then, you’ll be in such a groove that you’ll naturally start saving money as part of your regular routine.

• Open Your New Account 

  
  

Don’t make the mistake of keeping your emergency fund in your primary checking account. You want to avoid accidentally spending it. Your emergency fund should be earning more interest than your average checking account, so you should find an account with higher interest.

• Automate Your Savings 

  
  

Automating your savings is the key to saving. Many employers offer direct deposit, and some will even deposit funds into more than one account. Set up a separate savings account for your emergency fund and have your chosen contribution amount deposited automatically every paycheck, either by your employer or your bank. If you don’t see the money, you won’t be tempted to spend it.

• Don’t Touch It

  
  

When you have an emergency fund, it’s easy to spend it on anything other than an emergency. But you can’t do that. You need to set aside your emergency fund for emergencies only. If you really want to buy something, start a different savings account for it, but don’t spend your emergency savings.

• Stop at Your Goal

  
  

You’ve achieved your goals in your emergency fund. Now it’s time to move on to other accounts where you can invest more aggressively, such as your retirement accounts. If an emergency arises and you need to use some of your emergency funds, you should replenish what you’ve used.

Where Should You Put Your Money?

Where should you keep it when you’re ready to start saving for a rainy day? A savings account is a great place to keep your emergency fund. It should be kept in a separate bank account from your main account. You want to be able to access the fund quickly when you need it. And yet, you don’t want to have access to it so easily that you’re tempted to use it when you shouldn’t. 

A few options for where to keep your emergency fund include the following:

• High-Yield Savings Account 

  
  

An excellent option for starting an emergency fund is opening a high-yield savings account at an online bank. Online banks typically offer higher interest rates than traditional brick and mortar banks. 

However, you must transfer funds into and out of an online account using a secondary bank account. And this could cause a delay in receiving funds should an emergency arise. But, a high-yield savings account with an online bank is still a great choice for most people. 

• Money Market Account 

  
  

Money market accounts are similar to high-yield savings accounts in that they both pay you more interest than a basic bank account. And money market accounts typically include a debit card and check-writing capabilities making money easily accessible for an emergency.  

The downside of a money market account is some banks require a higher minimum deposit to open the account.

• Certificate of Deposit 

  
  

A certificate of deposit, also known as a CD, is a type of investment that can be used as an emergency fund. A CD is a way to keep your money safe and earn a higher than average interest rate on it for a set period of time.  

You can access the original funds plus the interest earned when the term is over. CDs typically pay a higher rate of interest than normal savings accounts. But, if you have to withdraw your money before the CD matures, there is usually an early withdrawal penalty.

When Should I Use My Emergency Fund?

Emergency funds are an important part of planning for the unexpected. The exact amount you should have in your emergency fund depends on your needs. For example, it is not an emergency to buy a new shirt, but fixing that broken furnace in the middle of January is essential. Align your spending with your values. 

It is critical to set aside a reserve fund for emergencies to avoid debt. Using credit cards or taking out loans to pay for these expenses can turn a one-time emergency into never-ending interest and fees.

Final Thoughts

Emergency funds are crucial, and if you don’t have one, you need to start building one today. Not having an emergency fund can lead to more debt that can take years to pay off, and it can also negatively affect your credit.

To start your new emergency fund, just follow these simple steps. Your emergency fund will help you feel secure and safe should you face an unforeseen emergency.