Emergency Fund: Everything You Need To Know

Learn what an emergency fund is and how you can begin planning for a more secure financial future.

Having an adequate emergency fund is critical for improving your financial wellness. Everybody has encountered unexpected economic costs, regardless of the magnitude. Incidental expenses, such as a surprise bill, a damaged laptop, a broken appliance or income loss, can occur at inopportune times. Rather than incurring high-interest credit card debt or taking out a loan to cover unexpected expenses, emergency money can cover the costs. While there are various reasons to establish an emergency fund, debt protection is among the most compelling.

What is an emergency fund?

Having an emergency fund means having money set aside for unplanned expenses, such as losing your job, experiencing a medical emergency, or an emergency car repair. A reasonable amount of money should be available to you immediately and readily. Emergency savings can cover high or small unexpected costs or payments that are not included in your usual bills and spending. Using money from your emergency fund to pay for unforeseen needs is preferable to using high-interest credit cards or a loan.

How to build an emergency fund

Now that you know what an emergency fund is and when it’s best utilized, it’s time to determine how exactly to build an emergency fund you can lean on. Below are a few tips to help you get started. 

1. Set a budget and determine how much money you can save

You need to know where your money is going to find savings possibilities. Using a budget as a tool for planning can help you maximize your earnings while also providing strategies for reducing or managing your expenditures. To effectively manage your finances, budgeting software is an essential tool. It supports you in forecasting your income and expenses, and provides a comprehensive overview of your financial status. After calculating how much you'll need in a month, you should decide on a monthly amount to set aside for your emergency fund.

Consider researching budgeting apps and programs to find one best suited to your unique needs.

2. Establish a savings objective

When you have a precise savings goal, it becomes much easier to stick to it. Creating an emergency fund may be the reachable goal that keeps you on the course, especially when you initially begin your financial planning journey. Calculate the time required to attain your financial plan based on your capacity to save money and how frequently you do so. This way, you'll build a habit of regularly saving, making it seem less overwhelming.

3. Automate your saving

You can automate your emergency fund contributions via direct transfer. You won't have to wonder if you're on track to meet your goals if you do it this way. A frequently used method is to set up automatic transfers from your checking account to your savings account through your bank or credit union. It is up to you to determine the size and frequency of your contributions, and once everything is in place, you will be making regular contributions to your savings account.

4. Evaluate and make adjustments to your contributions

After a few months, check in to see how much you're saving and make any necessary adjustments, especially if you've recently taken money out of your emergency fund. Consider growing your savings in small increments. For example, you could gradually raise your emergency fund contributions by a percentage or a set monetary amount until you meet your savings target. If you increase the amount in little increments, the change in your checking account balance will be less noticeable. You might invest the surplus money if you've saved enough to cover six months of expenses and still have money left over.

5. Hold on to your tax refund

There are specific periods during the year when you may get a large sum of money. A tax refund is one of the individuals' larger payments each year. Saving it can be a simple strategy to supplement your emergency fund. When filing your taxes, you can have your refund deposited straight into your emergency account. You may also consider contributing any additional excess funds to your emergency fund. 

6. Continue saving once you've reached your goal

Certain crises may require a cushion of over six months. Long-term unemployment and lengthy hospitalizations are both scenarios in which you'll be grateful for the additional cash in your emergency fund.

The benefits of an emergency fund

An emergency fund is likely not the only area you’re working towards building savings and value. If you’re feeling overwhelmed or still unsure of why you should plan for emergency funds savings, check out the five benefits below to learn more.   

1. It generates interest

One of the most significant advantages of having an emergency fund is that it will earn interest over time. More money in your account means more interest will be paid out. If you open a bank account specifically for this reason, choosing one that is conveniently accessible is critical. There are many options available, so choose one that earns a competitive interest rate but, more crucially, one that you have quick access to in the event of a financial emergency.

2. It helps avoid debt

When life throws you a curveball, it can cost you a lot of money, and if you aren't prepared for it, it can be a devastating blow to your financial stability. Nobody likes to incur debt if it can be prevented, which is why having an emergency fund is useful. You can save money on interest by not taking out a loan or using credit.

3. It helps to reduce stress

 When life throws an emergency at you, it jeopardizes your financial security and creates tremendous stress. Suppose you don't have a safety net. In that case, you are living on the financial precipice, trying to avoid a crisis. An emergency fund you can fall back on eases economic anxiety and gives you peace of mind in unanticipated bills. Relieving this stress can have a positive impact on many other aspects of your life as well. The benefits of an emergency fund extend beyond having cash on hand, and they also contribute to your overall health.

4. It safeguards you in the event of a job loss

Many people are concerned about job security in the current global economic environment. An emergency fund, with enough money saved to cover three to six months' worth of costs, might give you a much-needed financial cushion if you are laid off. If you work in a volatile industry, saving six months' worth of expenses may be prudent to ensure you are covered if finding another position takes longer than expected.

5. It teaches you how to be disciplined  

Creating a savings habit by depositing money into a savings account each month is an excellent habit to cultivate. If you have access to the funds on your debit card, you may be tempted to spend it on something unimportant instead of an urgent matter. Because the money is kept out of your immediate grasp, you won't be able to spend it on the spur of the moment, despite how much you would want to. It's also easier to track your savings in a separate account.

How big should your emergency fund be?

While emergency savings are beneficial, determining the amount to set aside can be tricky. Generally, aim for three to six months' worth of expenses. However, saving up to a year's worth of living expenses may be necessary sometimes.

What's the best place to keep your emergency savings?

Emergency savings should be kept in a savings account linked to your checking account. You might open a savings account at the same bank or go online and open a high-yield savings account. If you open a savings account with an online-only bank and simultaneously have a checking account with another bank, it might take 24 to 48 hours for funds to move to your checking account. Ensure you do the appropriate research before making big decisions.

It pays to plan ahead financially

Emergency funds act as a financial safety net, allowing you to stay afloat in difficult times without using credit cards or high-interest loans. In an emergency, knowing you have money set aside in a savings account can provide a sense of security. You will recover faster and get back on track toward your larger savings objectives if you set aside even a small amount of money for unexpected expenses.

Inkblot Therapy