An emergency fund is the money set aside that people can use in times of financial distress. This money is used for unexpected expenses or financial emergencies, such as a job loss, medical emergency, or major home repairs. It is generally recommended that individuals have enough in their emergency fund to cover three to six months of living expenses. This fund can provide a financial safety net to alleviate the stress and anxiety that comes with unexpected financial needs and can prevent you from falling into a debt trap of high-interest and unsecured loans or heavily relying on credit cards.
Create an emergency fund by following these steps
First, determine how much you need: Figure out how much you need to cover three to six months of living expenses, including bills, groceries, and other necessities.
- Set a savings goal: Set a specific goal for how much you want to save in your emergency fund and make a plan to reach it.
- Automate your savings: Set up automatic transfers from your checking account to your savings account. This way, you can save regularly without having to think about it.
- Cut expenses: Find ways to cut expenses to put more money into your emergency fund.
- Use windfalls: If you receive a bonus, tax refund, or another windfall, put it into your emergency fund.
- Track your progress: Keep track of your savings and adjust your plan to reach your goal.
Remember, this is a long-term savings goal, so be patient and don’t get discouraged if it takes time to build up.
Where to park your emergency fund
After creating an emergency fund, you must park it in highly liquid assets and ensure it does not deplete due to inflation. Keep the fund in a savings account or money market fund that is FDIC insured or a short-term certificate of deposit (CD), so your money is safe and easily accessible when needed. Some people prefer to keep their emergency funds in a bank or credit union savings account. These accounts typically offer easy access to the funds, low or no fees, and a relatively low-interest rate. Some people may also choose to keep their emergency fund in a money market account, which typically offers higher interest rates than a savings account but with more restrictions on the number of transactions that can be made. Ultimately, the key is finding an FDIC-insured account that is easy for you to access in an emergency.
When to spend emergency fund
An emergency must be used for unexpected expenses that are indeed emergencies. These are expenses that are necessary and cannot be put off, such as:
- Medical expenses: A major illness or injury can lead to costly medical bills that insurance may not cover.
- Job loss: An unexpected job loss can lead to a loss of income and unexpected expenses such as unemployment insurance and job search costs.
- Home repairs: A broken furnace, leaky roof, or other unexpected home repairs can be costly and must be addressed immediately.
- Car repairs: A car breakdown can make getting to work and other necessary places challenging.
- Natural disasters: A flood, fire, or another natural disaster can lead to unexpected expenses such as temporary housing, food, and transportation.
An emergency fund should not be spent on the following
- investing in stocks
- investing in mutual funds
- vacation
- buying a new phone or a TV
- paying off credit card debt or other loans
Conclusion
The ideal size for an emergency fund depends on factors like your financial situation, expenses, lifestyle, and debts. While most financial experts recommend saving enough to cover anywhere from three to six months’ worth of expenses, some experts suggest up to one year’s worth after having witnessed the 2020 economic crisis during covid. It is important to note that an emergency fund should not be used for expenses that can be planned for or are not truly necessary. It’s important to have discipline when using the fund, as it’s meant to be a safety net for unexpected, necessary expenses, not for lifestyle or planned expenses.
