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Emergency Funds 101

Life happens. You can bank on it–things break and need replacing, kids and pets all of a sudden need health care, jobs abruptly come to an end. So, expect the unexpected and start building an emergency fund to handle the inevitable curveballs life is going to throw at you. An emergency fund helps make it easier when things go wrong, and provides a financial cushion that makes unexpected expenses manageable, without breaking your budget or jeopardizing your financial stability. It’s also one of the best ways to start getting out and staying out of debt–having an emergency fund means that you don’t need to take on additional debt to cope with an unexpected car repair, for example.

Plan for the worst-case scenario

Emergencies come in all shapes and sizes. The most common reason people need to tap their emergency fund is an unexpected job loss. This is why most experts, as a rule of thumb, recommend having 3-6 months’ worth of expenses in a separate savings account (hint: online banks usually offer the highest interest rates) so if you or your spouse lose your job, you have sufficient time to find a new one—which may take longer than you might like. If you plan for the worst-case scenario, then you’ll also be covered for more minor unplanned expenses.

Just how much you need to save also depends on your individual circumstances. If you’re single, you may want to have six months of expenses, while someone who is married and whose spouse has a stable job may choose to have only three, especially if they are working to pay down student loan or credit card debt too. People with a variable income may want to have even more saved, as a cushion for those slow weeks or months in between paychecks.

How to get started

If you haven’t started an emergency fund yet, it’s never too late. The most important thing is taking that first step. Open a savings account (again, online banks pay the most interest). Just begin saving something, even if it’s only a small amount. Having even $25 or $50 transferred once a month from your checking checking to savings makes it automatic, so you won’t  have to think about it. Take small steps toward your larger goal. Make your initial goal $500, then aim for $1000, then 1 month’s worth of expenses. Keep going until you have enough saved to feel comfortable. If you get a windfall or even a large tax refund, use a chunk of it to jumpstart your emergency fund. Seeing that bigger number in your account can motivate you to maintain or even increase your savings rate. If you get a raise, plan to increase your savings proportionately.

Other ways to increase your emergency fund

  1. Save by eating at home more often, and limiting how often you get takeout food. Buy a good travel cup and make coffee at home to take with you.
  2. Round up your expenses, and deposit the difference into your emergency fund account every month. Or put your loose change in a jar and when it gets full, deposit it.
  3. There’s usually a limit on how much you can cut your expenses, but there’s no limit on how much you can earn. Babysit, offer pet care services to your neighbors, give lessons, or get a part-time job for a few months to build up your emergency fund.
  4. If you get an unexpected windfall, put some of it in your emergency fund.

Having an emergency fund reduces financial stress both now and in the future. Knowing that you’re prepared to handle an unexpected expense, should it arise, equals psychological peace of mind—and that’s priceless.

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