Managing your budget can be stressful, especially if you have an unexpected emergency pop up. Fortunately, there’s a way you can prepare for unexpected financial emergencies.
By building up a savings buffer—called an emergency fund—you can be prepared to pay for unexpected emergencies without having to turn to credit card debt, family loans, or other borrowing options that create unnecessary stress.
While an emergency fund won’t solve all your money problems, it’s a great start to getting your finances headed in the right direction.
Here’s exactly what an emergency fund is and what you need to know about them.
What is an emergency fund?
Before we break down exactly what an emergency fund is, let’s define what it is not:
- It is not used for planned purchases like a house, a new car, a college education, and so on.
- It does not have to a large, unattainable amount; it can start small.
- It is not a set amount for everyone—it varies based on your lifestyle.
An emergency fund is money you set aside for when an emergency upends your world and you need money to do what needs to be done.
Having an emergency fund gives you the peace of mind to know that should something truly awful happen, such as losing your job, you can worry about how to deal with the emergency itself and not worry about how you’re going to survive financially.
How big should my emergency fund be?
While a person’s emergency fund will vary from situation to situation, most financial experts agree that a fully stocked emergency fund should hold between three to eight months of monthly expenses.
Dave Ramsey prefers three to six months of expenses, while Suze Orman prefers eight months of expenses in a fully stocked emergency fund.
However, you don’t need to stress out about saving three to eight months of expenses overnight.
Just getting started? Build a small emergency fund first
Starting a small emergency fund of around $500 to $1,500 is the first step to building a fully stocked emergency fund. This smaller goal is much easier to reach and allows you to feel accomplished once you reach this awesome milestone in your finances.
Once you establish the small emergency fund, you can handle life’s small emergencies without going back into debt. This allows you to focus on gaining momentum when it comes to saving money rather than switching back to focusing on paying off debt incurred by small emergencies.
How do I determine what number to use for my monthly expenses?
While monthly expenses will vary from person to person, you’re basically ensuring that you could continue to live your life without bringing in any income. Some people make sure their emergency fund can cover luxuries while others stick to a more bare-bones emergency fund that provides just enough money to pay the bills.
It’s up to you to decide which monthly expense number you want to use, but we suggest picking a comfortable number that won’t make you feel stressed out should you suddenly find yourself needing to make the cuts you’ve budgeted for.
Why you need an emergency fund
So now that you understand what an emergency fund is, you may be thinking that they’re great for other people but you don’t really need one right now.
You may think your job is secure or you’re in a high demand field in which you could quickly find a new job. You may think using a credit card is a good enough emergency fund because you could always use a credit card with a 0 percent introductory APR on balance transfers until you pay off the debt.
Unfortunately, everyone will likely face at least a few financial emergencies in their life. Here are a few examples that should help you change your mind so you start building an emergency fund.
In case you lose your income
While most people think about being fired, that’s not always the reason you end up losing your income. What happens if you suddenly find out you need to move across the country to help care for a family member because they fell and broke a hip?
What would happen if your company suddenly gets bought out by a larger company, your department becomes redundant and you get laid off?
What would happen if the economy suddenly crashes over the next six months and your line or work is no longer in high demand? These are all real situations that could happen to anyone.
Of course, emergency funds don’t just cover you in the case of job loss. Other major financial emergencies can pop up as well. You may come down with appendicitis and have to pay your $5,000 deductible on your health insurance to get the necessary surgery.
Child and/or pet emergencies
What happens if your dog gets hit by a car and need $2,000 of vet care to live?
Or you may discover your child needs additional education services to help them keep up at school that cost thousands of dollars per year.
These things happen more often than you’d hope and can destroy your finances if you don’t have the cash sitting in an emergency fund to help pay for them.
What is an emergency?
Now that you understand that an emergency fund is a necessary financial tool, you need to figure out what is and isn’t a financial emergency.
Financial emergencies are unexpected major expenses that require you to use money immediately. In order to be an emergency, these expenses must be related to preserving your financial future, your health or your assets.
Here are a few examples of true financial emergencies where it would make sense to use your emergency fund.
- Job loss
- Unexpected medical expenses to maintain your health
- Sudden unexpected car breakdown or accident
- Sudden unexpected problem with a major system in an owned house such as an air conditioner, roof or electrical system
- A family member passes away and you need to purchase last minute travel to the funeral
- A family member gets hurt and you need to take time off work to provide necessary care
What isn’t an emergency?
While emergency funds are there to help you pay for emergencies, sometimes people stretch the idea of what an emergency is to access the cash they have put away.
Here are some examples of expenses that would not justify breaking into your emergency fund.
- Elective healthcare such as plastic surgery
- A great deal on a cruise vacation
- A last-minute request for you to fly to a destination wedding
- You want to replace your worn out carpet in your home with wood floors
- Your tires wear out from normal wear and tear (this should be budgeted, not an emergency)
- You really want to buy a new TV for the Super Bowl but didn’t save enough
Where to put your emergency fund
We like keeping our emergency fund in a high yield savings account or a money market account. This way, you have almost instant access to the money when you need it.
Additionally, high yield accounts allow you to earn at least a little bit of interest to try to ward off the effect of inflation. If you keep your money in an FDIC or NCUA insured account, your money is insured up to $250,000.
It often makes sense to keep your emergency fund at a bank separate from your main bank accounts. That way you won’t be tempted to dip into your emergency fund for everyday expenses. With that in mind, here are a few of our favorite banks you may want to consider when deciding where to keep your emergency fund.
The Discover Online Savings Account currently offer 1.90 percent APY on your savings.
They compound interest daily but pay interest on a monthly basis. There are no monthly fees to have a Discover Online Savings Account and there is no minimum deposit required to open your account.
Combine all of these factors and it’s clear why Discover Online Savings Accounts are a great candidate for your emergency fund.
HSBC Direct Online Savings Accounts currently offer 2.01 percent APY on the balance in your savings account.
HSBC Direct does have a minimum to open a savings account, but that minimum is set at just $1 which is low enough for anyone to open an account.
HSBC Direct does not charge monthly maintenance fees. HSBC Direct’s Online Savings Account checks off the major items you should look for when considering savings accounts for your emergency fund.
CIT Bank Money Market Account offers a money market account that currently pays 1.85 percent APY, although the interest rate is variable and may change at any time.
CIT Bank does require a $100 minimum deposit to open an account, but it does not charge account opening or monthly service fees. If you’re looking to maximize the interest you earn on your emergency fund, CIT Bank is definitely a contender you should consider.
How to contribute to your emergency fund
Build a Bank Account Buffer™
We’ve written in the past about 6.5 half steps to financial stability. The first and arguably most important step is to build a bank account buffer™ of $500 to $800.
If you’re in debt, it’s tempting to throw every extra penny towards your debt. However, it’s better the build at least a small bank account buffer™ of $500 to $800 dollars in savings before attacking your debt.
Those amounts may seem small, but when you’re in debt, they’re really not.
Moving forward, you can continue adding to your emergency fund with automatic bank transfers or a separate direct deposit of a portion of your paycheck to your savings account.
Since these actions are automatic, you won’t be tempted to skip saving for a paycheck or two. Instead, your emergency fund will grow in a disciplined manner every month.
Now that you have some money saved up, it’s time to invest and grow that money even more. If you’re new to investing, here’s a guide to get you started.
Open up a 401(k), and if your employer matches your contributions, take full advantage. And, to help keep your 401(k) on the right track, consider using Blooom—a 4o1(k) optimization tool.
Continue to grow your savings
As you can see in the picture above, starting an emergency fund is just the beginning of financial success. Now all you have to do is:
How to free up money to build your emergency fund faster
If you want to start building your emergency fund even faster, you have four ways to make it happen.
Cut your expenses
First, you can cut your expenses and save the money you cut out of your budget. Easy wins to help you save include cutting back on the number of times you eat out each month, negotiating your cable, cell phone, and other recurring monthly bills as well as temporarily cutting back on entertainment and other luxury expenses until your emergency fund reaches a healthy balance.
Bank all windfalls
If you don’t want to or cannot cut your expenses any further, you can focus on using “surprise” or “found” money solely to add to your emergency fund.
Typical sources of “found” money are tax refunds, bonuses from work, money from selling household items you no longer need, and money you receive as gifts.
Sell things you no longer use
Deposit any available cash you have or money you can earn from selling things you no longer use around the house. You can sell items locally on craigslist or Facebook Marketplace or you could sell things online through eBay or use services like Decluttr.
Make more money
Finally, one of the best ways to grow your emergency fund is to grow your income. After all, your income potential is technically unlimited.
You could start a side hustle, pick up a part-time job, work overtime, or start a small business in your free time. If you save all of the extra money in your emergency fund, except for any money you set aside to pay for taxes on the additional income, your emergency fund should grow quickly.
If you don’t have an emergency fund, you need to start building one today. Open a savings or money market account at Discover, HSBC, or CIT Bank and make your first deposit today. Work to cut your expenses, save “found” money or build extra income streams to build your emergency fund as fast as possible.