Why Do You Need an Emergency Fund?
- Job loss or unemployment
- Medical or dental bills
- Home repairs
It’s a fact of life: Unexpected emergencies happen. To everyone. It could be a blown transmission on the car, or even worse, the loss of a job. How prepared you are for one of these situations can make all the difference in a stressful time. But 66 million Americans have no emergency savings to fall back on, according to a survey by Bankrate.com. By taking steps to start an emergency fund you’re giving yourself the security of knowing you can cover unexpected expenses should the need arise.
66 million Americans have no emergency savings to fall back on.
Before taking steps to start an emergency fund (also known as a rainy day fund), you may need to level set on how, and when, this account will be used. Think of your emergency fund as money that’s set aside in a separate account to be used for emergencies. Managing this account requires discipline—it needs to be used for true emergencies (not included here: an upgrade to a new set of golf clubs).
It may take time to build an emergency fund, but there’s no need for the process to feel stressful or overwhelming. It’s all about having a plan, and these four steps to start an emergency fund can help guide you:
“Every financial expert sets some number as a benchmark for emergency funds—anywhere from three to six to 12 months of expenses,” says Kerri Moriarty, head of company development for Cinch Financial, a Boston-based startup building financial software. “For most people that’s just downright aspirational,” especially, she adds, when paying student loans, a credit card balance and rent or a mortgage.
Saving six months or more worth of expenses can feel daunting. That’s why it’s so important when figuring out how to start an emergency fund to begin with small goals and gradually work up to your long-term objective.
“Reduce your frustration and risk of de-motivation by setting milestone goals to work toward,” Moriarty says. “For example, building up $500 in emergency funds, then $1,000, then $2,500 and so on until you watch yourself tracking to one month or three months or six months covered.”
When you start an emergency fund the purpose is to have quick, easy access to your cash. To accomplish this, consider keeping at least the first three months’ worth of expenses in a high interest savings account so that you can access it at any time. After that, you could put any additional funds into low risk, high liquidity vehicles like a money market account or a certificate of deposit (CD). When considering how to start an emergency fund, think twice before investing in securities, since it will likely take days to unwind any positions to receive the money.
“Not only should you keep emergency funds in a separate account from your regular checking and savings, but it’s even better to keep them at a different bank entirely,” Moriarty says. “Keeping them at a separate bank reduces the temptation to draw from them when you’re checking the balance of your other accounts. Out of sight, out of mind—until you really need them.”
“Reduce your frustration and risk of de-motivation by setting milestone goals to work toward.“
Similar to a retirement fund, it’s important to pay into your emergency fund first. When you start an emergency fund, set aside a certain percentage of your take-home pay each month and put it straight into your account. You can set up either an automatic deposit on payday or a separate direct deposit with your employer as part of the steps to start an emergency fund.
But don’t stop there. Once you’ve started an emergency fund, find other creative ways to build your account even faster.
“When you start an emergency fund it can be challenging, but every few dollars helps,” says Brooke Petersen, investment consultant at Conrad Siegel, an investment advisory firm in Harrisburg, Pennsylvania. “Fund it with pay from extra working hours, a tax refund or part of a raise. Alternatively, bring your lunch to work a few days a week, or brew your morning cup of coffee at home.”
Finally, it’s important to remember that just because you might have reached your long-term goal to start an emergency fund, you shouldn’t stop there. Your circumstances could change through marriage or the birth of a child, for example, and your monthly expenses might increase as a result. When that happens you need to account for it. The six months’ worth of expenses you originally saved may no longer cover you.
Additionally, if you need to tap into this account at any point, then you will need to begin the process to replenish the amount you took out.
When you start an emergency fund think of it as a type of insurance policy for you and your family. You have health insurance in case you get sick, car insurance so that you’re covered in an accident and an emergency fund if something unplanned or unexpected happens.
“The primary investment objective for your emergency reserves is safety, not return,” Petersen says.
By learning how to start an emergency fund now you can avoid serious financial problems later. Take the steps to start an emergency fund one by one, and you’ll have peace-of-mind before you know it.
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