By Matthew Goldberg, Bankrate
What is an emergency fund?
An emergency fund is money that's set aside for unplanned expenses, such as medical bills, home repairs or loss of income. Using emergency savings to cover unexpected expenses is better than paying them with high-interest credit cards or taking out a loan.
Why an emergency fund is so important
An emergency fund is an essential part of a solid financial plan. Emergency funds allow you to cover unexpected expenses without having to use high-interest credit cards or take out a loan. That's why the time to start saving for an emergency is today.
"By nature, unplanned expenses are unexpected, so the sooner you're prepared the better off you'll be when the inevitable happens," says Greg McBride, CFA, Bankrate chief financial analyst.
People normally build up an an emergency fund to help them during some of the following unexpected events:
- Unemployment
- Urgent medical procedures
- Emergency home repair
- Unforeseen auto repair
- Sudden death or disability in the family
A Bankrate survey found that 4 in 10 U.S. adults could use their savings to pay for a $1,000 emergency. Having an emergency fund can provide peace of mind, an assurance that you have money when an unexpected expense happens. A 2021 Bankrate survey showed that a quarter of respondents didn't have any emergency savings.
How much to save in your emergency fund
An emergency fund should cover three to six months' worth of expenses. Saving that amount may take a while, so make small goals at first, such as saving $5 a day and then work your way up to a reserve to cover several months' worth of expenses.
Your specific savings goal will depend on your income and expenses. When setting a savings goal, focus on having enough to cover expenses, not on replacing your entire income.
Sole breadwinners, business owners or those with highly variable incomes might want to aim for nine to 12 months' worth of expenses in an emergency savings account.
Where to keep your emergency fund
The best place to keep your emergency fund is in a high-yield savings account, which offers quick access and pays a competitive yield. Look for banks and credit unions that insure deposits through the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA).
Online banks are good options for your emergency savings because you can't just walk into the bank and withdraw your cash. Online banks also typically offer higher yields than brick-and-mortar banks.
Sometimes there's more to choosing a bank than just the rate of return.
7 easy steps to get your emergency fund started
1. Make a budget and see where you can start saving more money
It's important to know where your money is going so that you can find ways to save. Budgeting helps you to maximize income and find ways to reduce or manage your spending.
A budgeting app is another useful tool that can help you calculate income and expenses to provide a dashboard view of your financial situation.
2. Determine your emergency fund goal
Determine the amount you need to save by reviewing your budget and calculating how much you need each month to cover essential expenses, such as housing, food and transportation.
3. Set up a direct deposit
Direct deposit eliminates the need to manually deposit a check or transfer funds between accounts, putting the money directly into your emergency fund. Automating the process can help you save regularly, helping to eliminate the temptation to spend rather than save.
4. Gradually increase your savings
Over time, increase the amount you're contributing to your emergency fund by 1 percent or a specific dollar amount, until you've reached your savings goal. Increasing the amount in increments will help to make changes to your checking account balance appear less noticeable.
5. Save unexpected income
At least a part of any windfall that you receive should be used to fund an emergency fund, unless you already have a sufficient one established. Unexpected money can come in the form of a tax refund, bonus, cash gift, inheritance, or winning a contest or the lottery.
6. Keep saving after reaching your goal
Some emergencies may require more than a six-month cushion. Being unemployed for more than a year or being hospitalized for several months are both situations where you'll be glad you have more money saved in your emergency fund.
7. Use a bank account bonus to jumpstart your savings
Banks frequently offer cash incentives to attract customers to open new savings or checking accounts. These bank account bonuses can be useful in establishing an emergency fund or adding to an existing one.
Read more: 5 Financial Moves You Must Make in Your 30s
Bottomline
An emergency fund is a sound way to stash money away for unanticipated needs that can eliminate the need for taking on credit-card debt or a personal loan. Saving money for emergencies in a high-yield savings account allows you to earn interest while also providing easy access to the funds when urgently needed.
See more at Bankrate
