If you’re like most people, chances are your household is living paycheck-to-paycheck. In fact, according to Northwestern Mutual’s 2019 Planning & Progress Study, two in five Americans (40%) have less than $5,000 saved for emergencies. This lack of savings can be particularly challenging when unexpected expenses arise, such as car repairs or medical bills. That’s why having an emergency fund is essential — especially if you want to avoid going into debt when faced with unforeseen circumstances. But what exactly is an emergency fund? And how do you build one? We’ll cover both of those questions below.
What is an Emergency Fund?
An emergency fund is money set aside specifically for covering unexpected expenses, such as:
Car repairs
Medical bills
Home repairs
Lost income due to job loss or reduced hours
Other unexpected expenses
Having enough money set aside for these types of situations can help prevent financial stress and keep you from going further into debt. So just how much should you save? According to financial experts, three to six months worth of living expenses is typically recommended. However, if you’ve recently lost your job or have other factors affecting your ability to earn an income, you may need to aim higher. For example, if you expect to be out of work for longer than three months, you may want to consider setting aside nine to twelve months worth of living expenses.
How Do I Build an Emergency Fund?
Building an emergency fund takes time, discipline, and patience. Here are some steps you can take to start building yours today:
Step 1: Determine Your Goal
Before you begin saving, decide how much you want to put away. Remember, the goal is to have enough money set aside to cover at least three to six months of living expenses. Once you know how much you need to save, you can determine how long it will take you to get there.
Step 2: Create a Budget
Your budget should include all of your monthly expenses, including rent, utilities, groceries, gasoline, insurance premiums, entertainment, and more. You can use a budgeting app or spreadsheet to make tracking easier.
Step 3: Set Aside Money Each Month
Once you know how much you need to save and how long it will take you to reach your goal, it’s time to set up automatic transfers from your checking account to your savings account. Most banks offer free online banking services, which allow you to easily transfer funds between accounts.
Step 4: Cut Back on Unnecessary Expenses
To increase the amount you’re able to save each month, cut back on unnecessary expenses such as dining out, expensive clothing, and subscription services you don’t really need. Instead, try cooking at home, buying used clothes, and canceling subscriptions you don’t use.
Step 5: Consider Other Sources of Savings
In addition to cutting back on expenses, you may also want to explore additional sources of savings. For example, if you have a flexible spending account through your employer, you may be able to contribute pre-tax dollars towards healthcare costs and other qualified expenses. Additionally, you may be able to deduct certain expenses from your taxable income, such as charitable contributions or education-related expenses.
Step 6: Keep Your Emergency Fund Separate From Your Regular Account
It’s important to keep your emergency fund separate from your regular checking account so you’re not tempted to spend it on non-essential items. If you’re using a savings account, make sure it has no fees and requires a minimum balance lower than your emergency fund. Alternatively, you could open a high-yield savings account or even a certificate of deposit (CD) to maximize interest rates and minimize fees.
Step 7: Review Your Budget Regularly
As you continue to save, review your budget regularly to ensure you’re still meeting all of your financial obligations. You may find that you need to adjust your spending habits or your emergency fund goal.
Why Building an Emergency Fund Matters
According to Bankrate’s May 2019 Financial Security Index survey, only about half of respondents said they had enough cash savings to cover an unexpected $1,0 expense. Without an emergency fund, you’re likely to rely on credit cards or loans to cover unexpected expenses. Another, more recent survey, Bankrate’s 2024 Annual Emergency Savings Report, indicates that people are saving more now, than they were one year ago. However, regrettably 1 in 3 American’s have more credit card debt than emergency savings.
Unfortunately, relying on credit to pay for emergencies often leads to financial trouble down the line. With extended pay off times, credit cards can cause a false sense of security, when in fact, it actually costs you money to use the credit cards, when you get charged high interest rates. Credit card interest rates can quickly add up, making it difficult to pay off what you owe before accumulating more debt. Additionally, missed payments can damage your credit score and lead to late fees. With an emergency fund, however, you won’t have to worry about debt accumulating while you recover from unexpected expenses. Plus, you’ll be better prepared to handle any situation life throws your way. So, what are you waiting for, start saving those pennies, every cent adds up!
