Emergency Funds: Your Financial Safety Net
(Originally published January 13, 2020) Whether you have a sudden loss of income or big, unplanned expense, an emergency fund can help you through tough times while limiting damage to your finances. Learn what an emergency fund is, why you need one and how much you should save.
What Is An Emergency Fund?
An emergency fund is money that you set aside to cover big, unexpected expenses or a sudden loss of income. Here are a few examples:
- Your car blows a head gasket and you're faced with a costly repair — or replacing your car entirely.
- What you thought was food poisoning turns out to be a stomach flu, and you have to take a trip to the emergency room.
- Your dishwasher springs a leak that requires professional help.
- That mandatory meeting at work is your boss telling you the company is downsizing and you are out of a job.
Is An Emergency Fund Worth It?
Aside from the peace of mind that comes with having a little extra money saved for a disastrous occasion, emergency funds help you avoid paying for unexpected expenses with a high-interest loan or credit card. This is especially helpful if you are working to reduce your existing debt from credit cards or loans. One of the best ways to get out of debt is not to keep adding to it.
How Much Should I Save for an Emergency Fund?
Emergency funds aren't a one-size-fits-all thing. There is no magic number or secret formula that will make sense for everyone. A good guideline is to save enough to cover three to six months of essential expenses in case you lose your job or can't work for several months. Essential expenses include things like housing (rent or mortgage payments), utilities, childcare, car payments and food.
To figure out how much to save, track your expenses for a month or two and note which expenses are must-haves and which are nice-to-haves. Add up a month's worth of must-haves and multiply by three to calculate your three-month savings goal. For more cushion, multiply your essential expenses by six to see your six-month savings goal.
How Can I Save for an Emergency Fund?
Don't panic if saving up six months' worth of expenses seems impossible. The important thing is that you start. Here are some tips:
- Set your savings goal: Saving for emergencies is like saving for anything else: You need to know your target amount. If the total is overwhelming, start with a micro-goal: Save $100 first, then another $100. Emergency funds don't grow overnight, but as long as they grow, that's all that matters.
- Commit to a specific, regular amount, like it's a bill: Look at your income and expenses and see how much you can dedicate to savings. If your expenses exceed your income, you'll need to re-examine your budget and either reduce your spending or increase your income so you can save money each month, even if it's a small amount.
- Set up automatic savings: Once you know how much you can commit to saving on a regular basis, consider setting up an automatic savings plan that transfers a fixed amount to savings according to intervals you specify (monthly, weekly or every two weeks, for example).
- Continue paying off debt: It can be tricky to balance everything but paying off debt will save you money on interest and fees in the long run. Find a debt repayment method that works for you and leaves room in your budget to save for a rainy day — even if it's just a few dollars a month.
Where Should I Stash My Emergency Fund?
Once you figure out how much to save and how you're going to save it, it's important to think about the type of account you are going to save it in.
Consider these qualities for your emergency fund account:
- Separate: Put your money in an account that's separate from your regular checking and savings accounts (the accounts you use for routine spending), so you aren't tempted to spend your emergency funds on everyday purchases. You can also try digital options to create separate fund categories without opening separate accounts. BECU offers Envelopes, for example.
- Secure: Check with your financial institution to be sure your money is protected. For example, BECU accounts are federally insured by the National Credit Union Association (NCUA) up to $250,000 combined, per individual account holder.
- Accessible: While you want to set your money aside and only use it in an emergency, you also want to make sure you can get to it when you need it. Even though a certificate of deposit (CD) might be tempting because of higher interest rates, you typically can't withdraw money from a CD until the agreed-upon term is over without paying withdrawal penalties. A traditional savings account might be your best option.
Getting in the habit of building your emergency fund may be hard, but if you ever have an occasion to use it, you'll be glad you saved.