How to build your emergency fund
The economic impact of the COVID-19 pandemic has taken a major toll on many American households.
The crisis has highlighted the importance of setting aside savings for an emergency fund that helps supplement income during unforeseen circumstances. Yet many Americans do not have enough money in their emergency fund—if any at all.
If you’re putting away money through a savings account, you still may not be properly setting yourself up to cover emergency expenses. That’s because an emergency fund serves a different purpose than your general savings account, and therefore needs an account of its own.
Whether you’re already building an emergency fund or are starting for the first time, here’s what you need to know.
Why having a separate emergency fund is essential
Many people look at a savings account as a place to store away extra cash for the long-haul. Savings accounts can be a good place to put away liquid assets for a rainy day or future purchases, but savers lump emergency funds into their general savings far too often. This leaves you with an ambiguous understanding of how much money you have set aside for emergencies, and how much you’ve saved for long-term goals.
When you open and fund a separate savings account for emergencies, you can better track how much you have on hand for unforeseen expenses. High-yield savings accounts and money market accounts usually offer the right mix of fast access to cash with the ability to still earn interest on your balance.
Other options, such as a certificate of deposit, often charge you for withdrawing funds early. They may offer higher interest rates, but you could end up having to pay a penalty if you need to withdraw funds in an emergency.
Calculating how much you need in your emergency fund
The more you can put aside in an emergency fund the better—but within reason. Set aside too little money and you may not be able to cover expenses in a crisis. Too much, and you might be missing out on opportunities to have those funds generate larger returns through other kinds of investments.
There’s no hard and fast rule when it comes to how large your emergency fund should be, but common wisdom says you’ll want to have at least six to eight months’ worth of income stashed away. The larger your emergency fund, the more cushion you’ll have to afford large bills or for extended periods in which you can’t work.
This figure differs depending on whether you’re in a single or dual-income household. If you have two sources of income, you may not need to bulk up as much on emergency savings. Having one source of income, on the other hand, makes it harder to guarantee that you’ll still have enough money coming in to cover emergencies. In this case, you may want to hit or exceed eight months’ worth of income in your emergency fund.
You may also want to think about other factors that are unique to your own financial and life situation, including:
- If you own your own home, you may want to make sure you have enough money to pay for emergency repairs.
- If you work in an industry with high employee turnover, you may want to put aside extra in the event that you have an extended period of time between jobs.
- If you or a family member have health problems you may want to consider how this impacts what you need in your emergency fund. Long-term conditions may leave you without the income you need, and insurance payments may not pick up enough of the tab on their own.
The best ways to save for your emergency fund
Spreading your money around between bills, expenses, retirement savings, and savings accounts can make it hard to see where there might be enough left over every month to start or grow your emergency fund. There are several ways in which you can start small to grow your emergency fund without sacrificing other savings goals.
One of the most pain-free methods of building your emergency fund is setting aside the change from debit card transactions. Many financial institutions offer this feature on their checking accounts, and there are smartphone apps that do the same. This is a modest way to contribute to your emergency fund that complements regular (and larger) deposits.
Your employer may also offer you the ability to deposit your paycheck into more than one account automatically. Typically this takes a percentage of your total paycheck or a specific dollar amount that goes into each account. With this option, putting money into your emergency fund becomes even easier. You won’t be tempted to skip regular deposits, forget to move money, or even be as acutely aware of these deposits coming out of your take-home pay.
Balancing your emergency savings and your regular contributions to a savings or retirement account can feel tricky as well. The key here is to do your best to balance each of them. Maxing out on your employer’s matching contributions (if available) is the best place to focus first, so long as you can still keep some liquid savings at the same time.
How to build your emergency fund when you’re in debt
It’s more challenging—but not impossible—to build and fund your emergency account when you’re paying down debt. By starting as early as possible and making affordable contributions, you can invest in your own financial safety while also taking care of loan repayments and other debts.
If you’re paying off debts, you’ll want to start small with your emergency fund. It’s often more important to get yourself out of debt first. Setting aside money for emergencies that could otherwise pay off a high-interest credit card ends up costing you more in the long-run. Consider starting an emergency fund with $1,000-$2,000, rather than months’ worth of income. This will help offset some lesser expenses without requiring you to add more debt to what you already have.
Plan today for a more secure tomorrow
There are several factors people need to consider when setting themselves up for a bright, safe financial future. The value of an emergency fund can’t be understated here, even if it may not get as much attention as retirement savings or having enough money to pay down debt and pay off bills. That said, not having an emergency fund to pull from can very well lead you down a path of taking on debt to pay for surprise bills or interruptions to your income.
Building an emergency fund takes time, but remember to go at the pace you need in order to get there. As you know the right steps and which options make the most sense for you, you can build up funds to help weather any storm.