by Having an emergency fund is basic personal finance, but the majority of people just don’t have one. No matter what your situation is, you should have some kind of emergency savings.
Currently, only 41% of Americans say they could cover a $1,000 emergency. That means they’re unprepared for a sudden, unexpected cost, like a car accident or a medical emergency. Those situations are stressful enough, but the added burden of being financially unprepared is something you can take steps to avoid.
Emergency Fund: Why It's Important and How to Get Started
What is an emergency fund?
An emergency fund is money set aside to cover large, unexpected expenses.
You could use an emergency fund to cover things like sudden medical expenses, replacing a defunct home appliance, funding a major car repair, or if your roof starts leaking.
But an emergency fund can also help you if you suddenly lose your job or have your hours cut.
Your emergency savings should be able to cover necessary and unexpected expenses. It’s not money you should use for vacations, a new TV that just went on sale, or anything like that. You should save for those kinds of things separately.
Related: In Case of Emergency Binder Review: Get Prepared for 2020
Why you need an emergency fund
Picture this. It’s the middle of the summer – I’m in Texas, so it gets miserable here – and your AC suddenly goes out. You call the HVAC guy and find out that you need a new unit, which will cost you $3,000.
What do you do?
Without an emergency fund, you might rely on a credit card to pay for your new AC, or have to live without it for the rest of the summer. But if you have an emergency fund, you can use that money to cover the expense.
Another possibility is needing some major car repairs after getting into an accident. Your insurance is going to cover it, but you still have to pay a $2,000 deductible. Instead of pulling out a credit card to “afford” the expense, you can dip into your emergency fund.
Your emergency fund is a buffer that protects you from taking on debt.
One thing that many people don’t realize is that even when you are trying to pay off high interest rate debt, having some kind of emergency fund is still a really good idea.
For more articles on protecting yourself and your finances, read:
How much money should you have in an emergency fund?
There’s no one-size-fits-all recommended emergency fund amount, because everyone’s situation is unique.
If you have high interest rate debt, having $500-$1,000 saved is a good starting place for your emergency fund. This is enough to cover some smaller emergency expenses and prevent you from adding to your debt.
After you’ve gotten rid of your high interest rate debt, you can start working towards saving 3-6 months of expenses. But how much you save is still very subjective.
- Self-employed people should have a larger emergency fund, anywhere from 6-12 months of expenses saved.
- If you have a chronic medical condition, it’s recommended that you have closer to a 6 month emergency fund.
- If it would be difficult to find another job that pays similarly to what you currently make, you should save on the higher end.
The more stable your income, the less you need. If you and your spouse are both employed at steady jobs where you know you can count on making a certain amount of money, three months saved might be enough.
But if you’re thinking about making a major job change – like when I quit my stable teaching job to blog full-time, you should be prepared with a larger emergency fund.
Related: 52 Week Money Challenge: Tips and Hacks to Save $1,000 (Or More!)
Where to save your emergency fund?
Your emergency fund needs to be liquid savings, which means it's easily accessible. One of the best places to keep it is in a high-yield savings account. These have higher than average interest rates, which allows you to earn a little interest on your money.
There is a growing number of online banks that have high-yield savings accounts. Many have low minimum balance requirements, zero fees, and some have some pretty sweet sign-on bonuses. You can read about my top online banking picks at Best Online Savings Accounts for 2020.
Just make sure your emergency fund is separate from your checking account or any other savings accounts. You should also avoid saving in an investment-type account – it can take a few days to access and you can end up losing money.
When to use your emergency fund
I gave you some examples of when to use your emergency savings, but there still might be some questions around what exactly qualifies as an emergency expense.
Emergencies expenses are unexpected, necessary, and urgent.
If you could have planned and saved for something, then that doesn’t qualify as an emergency expense. These are things like:
- Back to school supplies
- Regular car maintenance – oil change, new tires, new brakes, etc.
- Taxes
- Replacing a 25 year old water heater
- Annual insurance premium
- Annual vet visits
Some people might think those qualify, but those are all things you know are coming, so you can build them into your budget.
The broader your definition of emergency, the bigger your risk of depleting your funds and not being able to pay for true emergencies.
Here are situations I consider emergencies:
- You’ve lost your job
- A tree falls on your roof and you need to pay the deductible on your homeowner’s insurance
- Your pet gets sick and needs emergency vet care
- You’re injured while traveling out of the country and need to pay a medical bill
- A family member passes away and you need to fly out of town for the funeral
- You get a flat tire
- You have to take time off work to care for a sick family member
How to build an emergency fund
Now that you understand what an emergency fund is and why you need it, let’s talk about how to start saving.
1. Figure out how much you need to save
If you’re brand new to this, start with a $1,000 savings goal. But eventually you should save six months worth of expenses.
You can figure out what this amount is by adding all of your monthly expenses together and multiplying that by six. Some people only account for bare-bones expenses, while others will build in extras like haircuts, eating out, etc.
Pick an amount that feels comfortable for you. Remember, this is about reducing financial stress.
2. Put a monthly savings goal in your budget
Write a line item in your budget for funding your emergency savings. This way you’re paying yourself first and not looking at this savings as an afterthought. Even a goal of $50-$100 a month is better than nothing.
M$M tip: Zero-based budgeting is a really great way to build in savings goals, and here are a few more articles about budgeting if you need help creating one:
3. Set up automatic deposits
Automating your savings can make saving even easier. If your employer does direct deposit, you can see if they can deposit some of your paycheck into your emergency savings account. Automatic transfers from your checking account to your emergency savings account is another option.
4. Save up small amounts of money
If you use cash, start saving your change. You can also use an automatic savings app like Qapital to round up transactions from a linked card to the next dollar amount, then saving the change.
Read more at Qapital Review 2020: Save Money Without Even Noticing.
5. Save your tax refund or bonuses
Saving big chunks of money at a time can boost your emergency fund, and it’s also a good way to replenish your funds as you use them.
6. Find a side hustle
If you are struggling to save for your emergency fund, then that’s a sign that you might be living pretty close to a paycheck-to-paycheck lifestyle. You don’t need me to tell you that this is a stressful and dangerous spot to be in.
Increasing your income with a side hustle is one of the best ways to increase your income so you can save up for an emergency fund, pay down debt, or reach other financial goals. Even something small like selling your stuff online can help, but there are more lucrative side hustles that can have dramatic results.
Learn more at 22 Best 2020 Side Hustle Ideas (Make $1,000+ Per Month).
7. Adjust your emergency fund as your life changes
Not only will you need to save more if you use some of your emergency fund, you’ll also need to check in after going through any major life changes. Having a baby is a good reason to save some more – kids cost money and there are more people counting on you and your income. Buying a house, switching careers, and moving to a new city are all good reasons to save up a little more or make sure your savings are in a good place.
There are also reasons you might be able to reduce the size of your emergency fund, or at least move a portion of it somewhere else. Things like paying off your mortgage or student loans mean less monthly expenses to save for.
The final word on emergency funds
No one likes to think about emergencies -- it’s a reminder that we can’t control everything. But having an emergency fund helps you stay in control. It prevents stress and taking on debt.
Building your emergency fund might take some work, but you’re creating some peace of mind for yourself knowing that you can manage to deal with unexpected expenses. That is a powerful place to be.
About Millennial Money Man
Bobby Hoyt is a former band director who paid off $40,000 of student loan debt in 18 months on his teaching salary and then left his job to run Millennial Money Man full-time. He helps other Millennials earn more through side hustles, save more through budgeting tools and apps, and pay off debt. He is a personal finance expert who has been seen on Forbes, Reuters, MarketWatch, CNBC, International Business Times, Business Insider, US News, Yahoo Finance, and many other personal finance and entrepreneurship media outlets.
