So, you shattered your smartphone. Or you were hit with a big car repair bill. Maybe you had to see a doctor for a sinus infection. We’ve all been there. Emergencies, while unpleasant, are an unavoidable part of life. So it’s important to be prepared. The best way to do this? Having an emergency fund can help.
What is an emergency fund?
Think of an emergency saving fund as a plan for the unknown. It’s expecting the unexpected: You know that things will come up, even though you don’t know what those things will be, so you put money away to help cover you in the future.
Your emergency fund shouldn’t be the same as the money you’re saving for travel or holiday gift-giving. Instead, an emergency fund is your safety net, to be used only when financial crises occur.
Consider keeping your fund in a dedicated savings account, preferably one that is interest-bearing. The important thing is that you can access your money quickly, easily, and without penalty, which might not be possible if you choose a CD (time account) or savings bond that has a maturity date.
This might go without saying, too, but it’s risky to keep your emergency fund as cash in your apartment or dorm, because somebody could steal it. Even if you have renters insurance, you might not be able to recover the full amount lost.
Who needs an emergency fund?
In short: everyone. You’re never too young to start saving — starting before college may even be a good idea. Consider an emergency savings fund for several reasons:
- It helps you form a savings habit.
- It can help you stay more focused on attaining your goals, rather than stressing about an unexpected expense.
- It can help you get a financial head start.
- It can help keep you from resorting to using a credit card in an emergency, which means less chance of accumulating credit card debt - and interest.
How much should you save?
Wells Fargo Investment Institute recommends having three to six months' worth of living expenses in cash or cash equivalents.
However, if you’re just getting started, saving thousands of dollars can seem daunting.
Instead of becoming overwhelmed, just start putting aside money regularly. Imagine a likely scenario when you would need money and start with that as a goal: an unexpected doctor’s visit and prescription, a new phone if yours breaks, engine repair if you drive to work, or a last-minute flight home if there’s a family emergency. If you can save $25 a month, the money will accumulate over time. Consider saving until you have 5% –10% of your income in savings.
How do you create and keep an emergency fund?
We’re glad you asked. Follow these steps to get started on your way to financial preparedness.
1. Identify your “why.”
Knowing the reason you’re saving will help keep you motivated. Yes, you’re saving for emergencies, but think about what having an emergency fund can mean: less stress, more financial confidence, more independence, and less chance of incurring credit card debt you’ll have to work hard to pay off.
2. Know what you’re spending.
This is the first step to creating a budget. Track how much money you’re spending on food, fun, housing, books — everything. Knowing where your dollars are going will help you set a more realistic savings goal for your emergency fund.
3. Set your emergency fund goal.
Once you’ve created your budget, decide on an emergency savings goal. Once you’ve set it, figure out how much you’ll save each month (like $25 or more) to reach it.
4. Pay yourself first and make saving automatic.
Treat your savings like a bill to pay. This is easier if you automate your savings: When a direct deposit from your job hits your checking account, you can specify a percentage to go into your savings account. You could also set up an automatic transfer from checking to savings each month. This way, you pay yourself first without even thinking about it. Also, be sure to save any windfalls, like a bonus or your tax refund, to get even closer to your goal with little extra effort.
5. Reduce your spending.
Look for ways to cut back on your expenses, and put those dollars into your emergency fund instead. Maybe you could prepare more meals at home rather than ordering takeout, or cancel a streaming service you hardly use. Small steps can add up, big-time.
6. Adjust as you go.
Once you’ve been saving for a while, take a look at your progress. Has it been a breeze? If so, consider increasing the monthly amount you put into your emergency fund. Has it been difficult? That’s OK — as long as you’re making progress, you can make an adjustment.
7. Keep saving.
When you reach your goal, keep up the good work. Save for other big (but expected) purchases like clothing, vacations, or car maintenance. When you have savings to rely on, you can start planning your financial future.