Personal Finance 101: Emergency Funds

What Is an Emergency Fund?
•    An emergency fund is a financial safety net set aside in preparation for unexpected financial hurdles, such as job loss, large medical expenses, or home and auto repairs.
•    Experts suggest building an emergency fund that can cover three to six months of expenses.
•    Keeping your emergency fund in a high yield savings or money market account could give you a higher return compared to a traditional savings account. 

Imagine you get into a car accident or notice a hole in your roof. Perhaps your company is acquired, and the new owner shuts down your division, leading to job loss. Do you reach for a credit card and go into debt to cover expenses, or will you have money you can tap while you get things back in order? 

An emergency fund can help you stay on track. It’s a dedicated pot of money set aside for unanticipated expenses, such as job loss, home or auto repairs, large medical bills, or any other financial curveballs life throws your way. 

An emergency fund can help shock-proof your finances, but many people find it challenging to maintain. In fact, 40% of Americans say they don’t have the savings to cover a $400 expense in case of an emergency, according to a 2017 report by the Federal Reserve. Working toward building this safety net takes time and dedication, but knowing you have prepared to cover an unexpected expense can relieve a lot of stress and anxiety. 

Along with providing ready assets for a short-term need, an emergency fund also helps preserve your long-term plans. Should you face an unexpected expense, you won’t have to tap into your retirement savings—meaning you’ll avoid paying penalties for early withdrawals. And that way your retirement savings can remain hard at work for your future. 

How to Build an Emergency Fund
Building an emergency fund from scratch can seem daunting but taking small steps toward saving can add up. 

To get started on a savings plan, determine how much you want to set aside. Your exact goal will depend on your specific circumstances, but many experts recommend aiming for three to six months’ worth of living expenses. 

Those in dual-income households may be able to get by with less because their household income is diversified, while those in single-income households may want to put away more. If you have children or other dependents who rely on you financially, you’ll want to make sure you factor those costs into your emergency savings plan as well. 

To help determine how much emergency savings you may need, you can use an online calculator. For example, try this one from the American Institute of CPAs. 

Once you’ve settled on a savings goal, it’s time to get started. While working to build your emergency savings account, it’s important to continue making at least the minimum payment on your credit cards and, if possible, continue saving for retirement. 

Here are some ways to kickstart an emergency fund:
•    Commit to saving a certain amount, then set aside a portion of your paycheck to go directly toward your emergency fund via direct deposit or automatic withdrawals.
•    Look for opportunities to trim expenses, so you can put that money toward your emergency fund savings goal. For instance, you might decide to cancel unused subscriptions—for a gym, a streaming service, or a magazine subscription—and direct those funds toward your savings.
•    If you get a tax refund, direct that cash toward your emergency fund. Alternatively, you could adjust your tax withholding and put the extra money you receive in every paycheck toward your emergency fund.
•    Dedicate a portion of bonuses or raises to go toward your savings.
•    Consider selling any household items, clothes, or hobby supplies you don’t use, and putting the money you earn into your emergency fund.

Where to Keep an Emergency Fund
Your emergency fund should be relatively liquid, meaning you can access it easily and quickly without having to sell or cash out other investments. At the same time, you don’t want it to be so accessible that you are constantly dipping into it to cover everyday expenses. 

Keeping your fund separate from your regular savings or checking account can help ensure you don’t spend it on anything other than real financial emergencies. To maximize your savings, you might consider keeping your emergency fund in an account that earns more interest than a regular savings account. 

The following types of accounts may be a good fit for your emergency fund:
•    High yield savings account. These FDIC-insured accounts offer higher interest rates than regular savings accounts, giving you a better return on your money. 
•    Money market account. These accounts are similar to savings accounts but come with more flexibility. Like checking accounts, money market accounts allow you to write checks or make debit purchases, but they limit transactions to six a month and may require a minimum balance ranging from $2,000 to $10,000. (Note that money market accounts are not the same as money market funds. The latter is an investment that could lose value if the market fails, while a money market account is insured by the FDIC and the National Credit Union Association for up to $250,000 per depositor.)
•    Certificates of deposit (CDs). CDs generally offer the highest interest rates of all bank accounts. However, CDs can take months or years to mature, and withdrawing funds prior to a CD’s maturity date results in penalties and fees. CDs are also insured for up to $250,000 per person.

By setting a savings goal and then regularly contributing to your emergency fund, you’ll gain the confidence that you can handle financial emergencies—without jeopardizing your long-term goals.