How to Build Emergency Funds
Saving money is easier when you give your savings a specific job. Instead of putting money aside and hoping there will be enough when something happens, you can build savings around the expenses and situations you are most likely to face.
One of the most useful places to start is an emergency fund. An emergency fund is money you set aside for expenses you did not plan for and cannot easily put off. It can keep an unexpected expense from immediately turning into a credit card balance, loan, or request to borrow money from someone else.
You may also hear about sinking funds. A sinking fund works differently. It is money you set aside for an expense you know is coming, such as an annual insurance bill or car registration.
If you are just starting to save, you do not need several accounts with thousands of dollars in each one. Start by building a small emergency cushion, then increase it as you are able.
What Is an Emergency Fund (Unpredictable)?
An emergency fund is money reserved for an unexpected expense or financial situation that needs to be handled.
Think about the expenses that could cause a problem if you had to pay them tomorrow. Your car could break down. You could have an unexpected medical expense. Your hours at work could be reduced. You could lose your job. An essential appliance could stop working.
Without savings, even a relatively small emergency can become a debt problem. A $400 car repair might mean putting the entire bill on a credit card and then making payments on it for months. If you already have money set aside, you can use your savings instead.
An emergency fund is generally for necessary expenses, such as:
Housing
Utilities
Groceries
Transportation
Insurance
Essential medical expenses
Necessary repairs
Minimum debt payments during a period of financial difficulty
It is not meant to be your regular spending account. A concert ticket, vacation, new phone, or holiday shopping may be something you want, but those are not generally emergencies. Keeping the money separate can make it easier to tell the difference when you are tempted to spend it.
How Much Should You Save?
You will often hear that an emergency fund should contain three to six months of expenses. That can be a useful long-term goal, but it can also feel impossible if you are starting with $0 and your monthly expenses are already taking most of your paycheck.
You do not have to start there.
Your first goal could be $100. Then $250. Then $500. Once you reach that amount, you can work toward $1,000 or another amount that would cover the types of emergencies you are most likely to face.
For example, if you can only put away $10 from each paycheck, that is $20 a month if you are paid twice a month. At that pace, you would have about $240 after a year. If you receive a tax refund, overtime, a cash gift, or another unexpected amount of money, you could put part of it toward the fund and reach your goal sooner.
If you can save $25 per paycheck, you would have about $600 after a year on a twice-monthly pay schedule. The amount you can save may change over time, so your emergency fund does not have to grow at the same rate every month.
Once you have some money saved, you can decide what a larger emergency fund should look like based on your actual expenses. Someone who lives alone and has few financial obligations may need a different amount than someone supporting children or dealing with an unpredictable income.
The important part is having money available before you need it.
Where Should You Keep It?
An emergency fund needs to be accessible when something goes wrong, but it should not be so easy to spend that it becomes part of your everyday budget.
A separate savings account is a simple place to start. Keeping it separate from your checking account can make it less tempting to spend the money on routine purchases.
If you are comparing savings accounts, you may come across high-yield savings accounts that pay more interest than some traditional savings accounts. You can compare the interest rate, fees, minimum balance requirements, and how easily you can transfer money out when you need it.
You do not need to invest your emergency fund in stocks or other investments to make it grow. The money's primary job is to be available when you need it. An investment can lose value at the exact time you need to withdraw the money, which can create another problem during an already difficult situation.
If you have a checking account at one bank and a savings account somewhere else, that is also an option. Just make sure you understand how long transfers take. If your car needs an emergency repair today, you do not want to discover that moving the money to your checking account will take several business days.
What Is a Sinking Fund (Predictable)?
A sinking fund is money you save for an expense you know is coming.
The difference is timing. An emergency is something you did not expect. A sinking fund is for something you can reasonably anticipate.
Your car needing maintenance is not necessarily an emergency if you know it will need an oil change, new tires, or registration. Your annual insurance payment is not an emergency if you know when the bill is due. The holidays are not an emergency because they happen at the same time every year.
Instead of waiting until the bill arrives, you can divide the expected cost into smaller amounts.
For example, suppose you expect to spend about $600 on car maintenance and registration over the next year. Saving $50 a month would give you $600 after 12 months.
You can use the same approach for expenses such as:
Annual insurance payments
Holiday gifts
School expenses
Home repairs
Pet expenses
Birthdays and celebrations
Planned travel
Replacing an aging appliance
The important distinction is that your sinking fund should not replace your emergency fund. If you spend your emergency savings every time a predictable expense arrives, you will not have much left when an actual emergency happens.
How to Save When You're Broke
Saving is harder when there is not much left after rent, food, transportation, utilities, and other necessities. If that is your situation, setting an unrealistic savings goal will not make the money appear.
Start with an amount you can actually maintain.
You might transfer $5, $10, or $20 into savings each payday. You might move the money manually after your paycheck arrives instead of setting up an automatic transfer. You might save only during the months when you have enough money left over.
You can also look for money that is already leaving your budget. If you cancel a subscription you rarely use, save the amount instead of absorbing it into your regular spending. If you finish paying off a small bill, consider redirecting that payment into savings. If you receive extra money from overtime, a tax refund, a gift, or selling something you no longer need, putting some of it into your emergency fund can give your savings a larger boost without requiring you to find more room in your normal paycheck.
Even something as simple rounding up your change after purchases can quickly add up. Methods like this we will explore further in our Everyday Money series.
You do not have to save every extra dollar. If putting $100 of a $500 refund into savings is realistic, that is still $100 more than you had before.
Your first emergency fund does not have to cover six months of expenses. Its first job may simply be keeping a $300 unexpected expense from becoming $300 of new debt.
As the balance grows, you can increase the goal. Eventually, you may want enough to cover several months of essential expenses, particularly if replacing your income would take time or you have significant financial responsibilities.
Final Thoughts
An emergency fund is one of the first savings goals worth working toward because it gives you somewhere to turn when an expense cannot wait. You do not need a large amount of money to begin. A separate account with $10 in it is still a start.
Build the fund in stages. Start with an amount you can realistically save, protect it from everyday spending, and increase the balance when your circumstances allow. Use sinking funds for expenses you can anticipate so that your emergency savings remains available for the things you could not plan for.
Up Next: Saving money is only one part of managing your finances. Your financial history can also affect the opportunities available to you, from borrowing money to renting a home. In the next article, we'll break down what a credit score is, what it measures, and why it matters even if you are not planning to borrow money right now.
Pardon our ads, they allow us to keep our site running and keep our helpful content free to access.
Comments