Starting an Emergency Fund

This article will walk you through the steps involved in setting up an emergency fund and making it grow.

Starting an Emergency Fund

This article will walk you through the steps involved in setting up an emergency fund and making it grow.

Starting an emergency fund is vital if you want to be able to meet unexpected expenses without having your financial situation derailed.

Emergencies are, by definition, unpredictable. They are the curve balls that life occasionally throws at you, often when you least expect them.

An unforeseen medical expense, a sudden loss of income, or even a broken-down car or home appliance can wreak havoc on your finances if you aren’t prepared. Big or small, unexpected expenses are a test of your financial integrity and foresight.

While there’s no way you can prevent an emergency, you can cushion their blow by planning ahead.

What Is An Emergency Fund?

Simply put, an emergency fund is a sum of money set aside regularly for unplanned but unavoidable expenses. It is distinct from your regular savings or special funds for education, vacations, and retirement.

An emergency fund is a financial safety net that you must carefully budget to tide over a major or minor financial crisis.

A dedicated emergency fund is a protective strategy to help you remain financially buoyant despite desperate unexpected circumstances. Planning for one could well mean the difference between being able to bounce back from a temporary financial setback or becoming insolvent as a result of it.

In the wider context of your long-term goals, an emergency fund can help you get back on your feet quickly after a crisis without jeopardizing the financial ambitions of you and your loved ones.

Why Do I Need An Emergency Fund?

Aside from the reasons given above, you need an emergency fund because it makes good financial sense.

A recent Bankrate survey found that more than half of all Americans do not have enough savings to cover an unplanned $1000 expense. Put another way, what the survey found was that 6 out of every 10 Americans didn’t have a way to pay for an emergency room visit or a sudden car repair.

The same study also found that one in five US adults would put the entire $1000 expense on their credit card and pay it back in installments - a very expensive proposition.

As if that was not alarming enough, a 2021 Bankrate survey found that 25% of all American households had no savings at all.

  • $1,000

    More than half of Americans do not have enough savings to cover an unplanned $1,000 expense

How Much Should I Save For An Emergency?

The short answer to that is whatever you can under your present financial circumstances. The important thing is that you realize its importance and start putting away something for a rainy day.

The 50/20/30 Financial Guideline gives you a baseline for the amount of money you need to put in your emergency fund. This guideline suggests that to achieve some kind of financial stability, you need to divide your total monthly expenses into three categories.

The first 50% should go to mandatory expenses like rent and utilities. No more than 30% of your total monthly income should be towards wants, like personal care, entertainment, and shopping. The remaining 20% should be devoted to building savings and paying off debt.

You should calculate your emergency fund savings at a fraction of this 20%, based on your specific financial conditions and current financial obligations.

Setting aside even $200 per month will leave you with a comfortable $2,400 at the end of the year to cover unexpected expenses. That’s a good enough start.

The basic calculation for an emergency fund is to have it cover at least three to six months’ worth of expenses. Of course, your actual savings will depend on your total monthly income and expenses. If you are the sole breadwinner of the family or if you have a variable income, aim for 9 to 12 months’ worth of expenses.

Where Do I Put My Emergency Fund?

The best place to stash your emergency funds is in an easily accessible but high-interest-yielding savings account at a federally insured bank or credit union. Other banking products like certificates of deposit (CDs) and individual retirement accounts (IRAs) come with early-withdrawal penalties, so they are not ideal for your emergency funds.

Online banks and credit unions are a good option to explore because of their lower fee structure compared to conventional brick-and-mortar banks. Just make sure to choose an online bank where deposits are insured by the Federal Deposit Insurance Corporation (FDIC) or NCUA (National Credit Union Association).

You should avoid putting your emergency money in assets like mutual funds and stocks, where they may lose value if you need to access them quickly.

When Should I Use My Emergency Fund?

There are objective as well as subjective issues linked to this question that you’ll need to carefully figure out. It’s difficult to put down what constitutes an emergency and what doesn’t because it might differ from person to person.

Not every unexpected expense is an emergency. The balancing act required here is deciding whether a certain circumstance calls for you to tap into your emergency fund or put it on your credit card. The latter option involves fees and interest that could make your final expense significantly larger than the original bill.

Set up some guidelines to cover this question in consultation with your family and loved ones. As long as your saving skills are strong, you can build your emergency fund back up again, even if you have to spend it all.

How To Build Your Emergency Fund

It’s one thing to plan and quite another to do it. Here are some of the steps and considerations you need to go through to start building your emergency fund:

  • Determine your budget: There’s no fixed rule about how to calculate emergency funds. The 50/30/20 rule described above is the ideal starting place while trying to determine your emergency fund budget. It proposes you set apart 20% of your monthly income on savings, a portion of which can go into your emergency fund. Ideally, saving for emergencies shouldn’t disrupt your everyday expenses or other saving plans.

  • Establish your goals: Be realistic in figuring out how much you can put away in your emergency fund every month and what that translates to over the year. Begin with small goals. Even a $5 or $10 daily put away for emergencies eventually starts to add up. As long as you have realistic goals and access to things like health and disaster insurance, you should be fine.

  • Gradually increase savings: Use extra income like bonuses, tax refunds, or inheritances to prop up your emergency fund. Use at least a part of any windfall gains like these to gradually increase what you’re saving for emergencies. There’s nothing like unexpected income to help you with emergency expenses.

  • Automate savings to your emergency fund: If you have a fixed salary, you can easily divide your monthly earnings into different accounts, including one for your emergency fund. This way, your monthly savings target can be met without your having to intervene manually.

  • Adjust periodically: Check in every few months to keep track of how much you’re actually managing to save in your emergency fund. Make necessary adjustments if you have to make a withdrawal to meet an unexpected expense. Maintain a level of positive flexibility with your emergency fund until you feel comfortable with your savings.

  • Keep saving even after achieving your goals: There could be unforeseen circumstances like being unemployed or hospitalized for several months that can severely strain your resources. So it’s important to keep your emergency fund growing even after you’ve reached your initial goals. Set up a goal of incrementally increasing your contribution to your emergency fund by a given percentage or sum.

Beyond Emergencies

A robust emergency fund aims to help you achieve and retain financial stability throughout your life. Circumstances can change rapidly, and it’s always better to be prepared for the unexpected.

An emergency fund is a buffer that ensures your long-term financial goals do not get derailed by a sudden and unexpected expense. You can always expect a more rewarding financial life when you have something to fall back on.

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