One of the major financial lessons emerging from COVID-19 is the importance of having an emergency fund. Do you find yourself stressed and losing sleep because of financial worry? Do you have an account you can access with enough funds to take the worry out of unexpected expenses?
If you can’t, you aren’t alone. Almost 30 percent of Americans don’t have an emergency fund, but it’s never too late to start one.
What is an Emergency Fund?
An emergency fund helps in unplanned emergencies. Your car breaks down, your furnace stops working, or you have a medical crisis – these are emergencies. They aren’t finding the perfect pair of shoes on sale or taking your dream vacation. Emergency funds are for unexpected emergencies that require your immediate attention.
Ideally, you should save three to six months of expenses in your emergency fund to achieve financial independence for women. For example, if your monthly expenses are $3,000, have $9,000 to $18,000 saved.
It sounds like a lot, but don’t get overwhelmed. We’ll discuss how to save an emergency fund later in the article.
Why do you Need One?
Ask yourself how you’d pay for an emergency. Your car breaks down on the side of the road. You need a tow, repairs, and a rental car. The total is $3,000. You live paycheck-to-paycheck. How do you cover it?
If you charge it, you’ll pay a lot more than $3,000. Now what? You increased your monthly obligations, derailed other financial goals, and forced yourself to pay interest on an expense you could have paid cash for if you saved an emergency fund.
Not only that, but emergency funds provide peace of mind. Emergencies are scary enough without the panic financial issues create. An emergency fund lets you manage an emergency without worrying about money.
Is $1,000 Enough in an Emergency Fund?
Saving three to six months of expenses seems unachievable. Using our $3,000 monthly expense example, thinking about saving $9,000 is overwhelming. Don’t let it overwhelm you, instead break it down.
Start with a $1,000 emergency fund. $1,000 covers basic emergencies. Don’t stop there. Once you save $1,000, which seems a lot more achievable, you’ll motivate yourself to keep going. After all, it’s a lot easier to save $1,000 than it is $9,000, but you’ll need that $9,000 eventually.
How to Start Your Emergency Fund
You know how much you need; now how do you start? It starts with budgeting. Do you have a budget or do you need to start one? If you aren’t already budgeting, you need one.
Start by totaling up your monthly expenses and monthly income. Categorize your expenses so you see where you spend the most, where you overspend, and where you do things right. Next, choose a budgeting method:
- Cash envelope method – Create an envelope for each category and fill it with the budgeted cash. Once the envelope is empty, you’re done spending in that category for the month.
- 50/30/20 budget – Allocate 50 percent of your income for fixed expenses (mortgage, car, utilities, etc.) and 30 percent for your wants, such as shopping, entertainment, or ‘extras’ like super-fast internet. The last 20 percent covers your debt repayment and savings (emergency fund).
- Zero-based budget – Give every dollar a ‘job.’ At the end of the month, your spend/checking account should have $0 because each dollar does something, including funds your emergency account.
No matter the method chosen, make funding your emergency fund a line item just like making your mortgage or car payment.
Determine how much you can budget for your emergency fund, starting with the $1,000 goal. Let’s say you can budget $250 a month for now. It would take you 4 months to save $1,000. That was fast, right? In a year, you’d have $3,000 saved before interest accrues.
Once you start, think of other ways you can save. Are there expenses you can cut or eliminate? Do you get windfalls, such as a work bonus or a tax refund? Direct them into your emergency fund to boost your savings faster.
Where to Keep an Emergency Fund
Emergency funds should be liquid, or easily accessed. Investing the money in a CD or stocks isn’t smart. You need immediate access to the funds. Waiting for liquidation (selling a stock) or paying penalties for early withdrawal (CD), takes time and unnecessary funds.
Instead, find a high-interest liquid account, such as a high-yield checking account or money market account. No matter where you choose, make it separate from your regular spend/checking account. Remove the temptation to spend it by making it harder to access regularly, but keep the information handy should you need it in an emergency.
Online savings and high-yield bank accounts are a great option. Not only do they provide higher APYs, but they also have fewer (sometimes no) fees and aren’t easily accessed. Ally Bank, Discover Bank, and Capital One 360 offer great options.
Making Saving for an Emergency Fund Easier
You know what you need to do and even where to save your emergency funds, but how do you make sure you stick to it? Use these quick tips:
- Automate your savings – Set up direct deposit into your chosen emergency fund account right from your paycheck.
- Round up your purchases – If you can’t contribute much to your emergency fund, consider a bank like Chime that rounds up your debit card purchases to the nearest dollar and invests your spare change.
- Cut expenses – Go through your budget with a fine-toothed comb. Cut out unnecessary subscriptions, negotiate bills like your cell phone bill, negotiate lower credit card APRs, and shop for cheaper insurance. Save any money you save, even if it’s a few dollars.
An emergency fund is a critical aspect of building a solid financial foundation. Knowing you have money to cover the unexpected brings peace of mind. It’s amazing what you can do with that peace of mind – you may find you make more money or get more creative with your savings just knowing you aren’t under pressure should an emergency occur.