An emergency fund is something everyone should have—regardless of income level or financial background.
While unexpected life events happen without warning, there are ways to prepare in advance to be ready for a rainy day.
Building and maintaining an emergency fund is one of the most crucial steps in preparing for an unforeseen circumstance which helps you avoid costly borrowing or even bankruptcy.
An emergency plan prepares you for life’s unexpected events and eliminates any feelings of regret or panic that come with them.
If you do not build an emergency fund, you may have trouble coping financially when emergencies arise.
So how do you build an emergency fund? What should you be putting into it? What should you do after building your emergency fund?
Continue reading to find answers to these questions and more to take care of unexpected expenses.
But before then, it is important to first understand what an emergency entails.
What is an Emergency?
An emergency refers to a sudden danger to life, health, environment or environment. Most cases of emergency need immediate action to prevent the situation from deteriorating.
Anything that puts you into financial jeopardy qualifies as an emergency. This includes unexpected medical bills, the loss of a job, car repairs, or damage to your home.
An emergency can be caused by natural hazards such as floods and earthquakes. An emergency can also be caused by human actions such as accidents, explosions and the discharge of toxic substances.
In any emergency situation, you need to know how to protect yourself, your family, your home and your property.
To plan for all sorts of emergencies, you need an emergency fund.
What is an Emergency Fund?
An emergency fund is money set aside in case of unexpected expenses that could hurt your budget. It is a fund set up to cover unexpected expenses such as medical bills, job loss, or home repairs.
Having an emergency fund makes it easier to handle emergencies without going into debt or bankruptcy.
You may be able to take care of the expense out of your current income and savings, without having to worry or rely on someone.
At some stage in your life, you’ll almost certainly have to deal with an emergency caused by an unforeseen circumstance or a decrease in income.
These unexpected events often don’t give you enough time to change your budget.
When your car suddenly needs thousands of dollars in repairs, or you find your landlord has double-billed you—you’ll thank yourself for having an emergency fund.
You may not predict what’s around the corner, but at least you’ll be prepared, and won’t have to put your plans on hold because of the things that may crop up.
A well-balanced emergency fund is your ticket to stability, security and freedom.
Emergency Fund Examples
The blow from a sudden big expense can affect your entire household and make it difficult to pay bills and even put food on the table.
Here are some examples of real emergencies where it is ideal to use your emergency fund:
- Job loss
- Unforeseen medical treatment is required.
- An unexpected vehicle breakdown or accident.
- An unplanned home or property repair.
- Loss of a family member.
- When a family member is sick, and you need to stop working to care for them.
Rather than missing out on an opportunity because you don’t have enough cash available, build an emergency fund to ensure that you always have the money you need.
You’ll have peace of mind knowing that your rainy day fund is there to cover expenses for whatever circumstance.
What are the Types of Emergency Funds?
Short-Term Emergency Fund
A short-term emergency fund is typically set aside to pay for immediate expenses that may arise from time to time.
The aim of your short-term emergency fund is to cover smaller unexpected expenses like car repairs or repairing a broken appliance.
In the event of a more serious emergency, it can also be used to get you over the next few days before you can access your long-term emergency funds.
This money should be accessible at all times and goes toward immediate financial needs rather than long-term goals like retirement or college savings.
Long-Term Emergency Fund
A long-term emergency fund is a great way to build up savings for large unexpected expenses, such as natural disasters or job loss.
This type of emergency fund will not only help you get through unexpected expenses but can also help you build wealth.
With a long-term emergency fund, you’re ready for anything. It could help cover expenses if you were to lose your job or your ability to work.
A long-term emergency fund could also be used to provide immediate assistance to families in the event of a natural disaster.
A long-term emergency fund should ideally be kept in a safe, liquid investment, such as a money-market fund.
What Should Be Included in an Emergency Fund?
You never know when an emergency will strike. You could lose your job, encounter a serious illness, or have to pay for major repairs to your home or car.
An emergency fund provides peace of mind and protects against a major unplanned expense or a loss of income.
But what do you put in the fund? While this depends on the type of emergency fund choose, all your regular and major expenses should be part of your emergency fund.
The following are some of the features of an emergency fund:
- Food expenses
- Personal expenses
Anything that would affect your lifestyle or make you indebted should be included in your emergency fund.
Why do You Need to Build an Emergency Fund?
Unexpected Job Loss
Create a safety net for yourself and your family with an emergency fund that will help you handle any financial setbacks when you lose a job.
When you’re short on cash, it’s tempting to use your credit card or withdraw money from your retirement account to get by.
While this might pay the bills in the short term, it’s a surefire way to get yourself into debt that will take years to pay off.
An emergency fund helps you withstand hiccups in your income by providing quick access to cash but staying far away from interest charges.
Unexpected Medical Expenses
Every year, millions of people face medical expenses that they did not necessarily plan for.
In the event of a medical emergency, you could wake up in the middle of the night with a baby who needs to be admitted to the hospital.
You never know when a sudden illness or accident will hit. The cost of this unexpected event can turn your life upside down!
An emergency fund can help you take the stress and financial pressure off of you and your family in times of medical crisis.
Even if you have health insurance, it’s important to have an emergency fund to cover the expenses that are not covered by insurance.
Unexpected Home Repairs
Life is unpredictable and an unexpected expense could cost you thousands of dollars.
You never know what will hit your home: natural disaster, fire outbreak, roof repairs, pipe freezes, etc.
This is where an emergency fund comes in. It’s a safety net to cover unexpected expenses so you always have the money you need to get the job done.
To avoid incurring more debt or dipping into your savings, you can use your emergency fund for unexpected home repairs.
With unexpected home repairs like replacing your heating and air conditioning or dealing with a water heater leak, having an emergency fund can make all the difference.
An unexpected trip could easily reduce your savings or even wipe out all of your cash reserves.
An emergency fund can provide you with peace of mind, in the event you experience an unexpected trip.
You don’t want to be caught unprepared when a sudden trip arises, because it can impact your finances negatively.
The sooner you build up an emergency fund for yourself, the more comfortable life will be when those unexpected expenses rear their ugly heads.
Unexpected Car Repairs
Never be caught off guard by a pricey car repair. A big reason why emergency funds are important is unexpected car repairs.
For example, the average cost of a radiator replacement is around $292 to $1193. And that’s just for one repair!
What happens when you can’t pay those off immediately? The vicious cycle of debt begins and it’s tougher than ever to step out.
To protect yourself from unexpected car repair expenses, it’s essential to have an emergency fund at hand.
If you’re not prepared with an emergency fund, you may end up in debt trouble if your car is suddenly in the shop for a week-long repair.
Unexpected Family and Pet Emergency
Having an emergency fund is an important part of being financially ready for unexpected events that may happen to your family or pet.
What happens when your dog suddenly needs surgery? Or you find that your child wants extra education programs that cost thousands of dollars a year to improve their performance in school?
These are some unforeseen expenses that can create havoc on your budget.
Instead of borrowing money to pay them, or skipping your investment contributions to cover the expense, have an emergency fund in place to pay for these inevitable costs.
How to Build an Emergency Fund?
Set a Target Amount
The first step of building an emergency fund is to set your target amount based on your situation and income.
It’s a smart idea or put three to six months of living costs in an emergency fund, according to most financial experts.
To set a realistic target, you will need to decide exactly how much you would need to spend per month on:
- Debt payments etc.
For example, if your monthly costs are $3,000, then you should try to save between $9,000 to $18,000 or more. But if your monthly costs are $5,000, you will need to save between $15,000 to $30,000 or.
If planning for several months of expenses sounds stressful, this is natural, especially if your budget is tight or you’re living paycheck to paycheck.
Determine how much you would like to put and make sure that a reasonable amount is deposited on a regular basis.
Create a Budget
The next step after setting a target amount for your emergency fund is to create a budget. Create a realistic budget to determine the amount of money you can regularly dedicate to your emergency fund.
The whole idea is to plan how much money you can set aside every month, then stick to it.
Look for places to cut on your budget in order to allow space for monthly emergency savings.
Total all expenses and write down the necessary amounts for housing, utilities, transportation, food, recreation etc. The key is spending less than you normally would.
As your circumstances change, so you will need to update your budget from time to time.
Open a Separate Emergency Savings Account
Once you have a created a budget, opening a separate account for an emergency fund is the next step.
Open a new savings account and make sure to add as much as possible to for a reliable emergency fund.
Compare all of the options to locate financial institutions that have a savings account with a good return and minimal fees before deciding which one to go with.
Opening a separate savings account develops a psychological separation between the amount of money you can use and your savings.
Joining your emergency funds with your regular chequing account will increase your chances of spending the full amount because it is easily accessible.
With that in mind, put some safeguards in place to ensure that your funds aren’t lost due to your own negligence.
It is wise to open an emergency savings account at a bank other than your usual bank.
But if you want to open an emergency savings account at your usual financial institution, then you must that you don’t link your bank card to it.
Accordingly, the best place to keep your emergency fund is in an account with a high interest rate of return, such as EQ Bank’s Savings Plus Account.
Automate Deposits into Your Savings Account
At this point, you have a separate account for any payments that you consider to be a priority, so now you must automate the deposits to land into your account directly.
You can automate your deposits through online banking, or by visiting your financial institution.
Your fundraising efforts should be integrated into your financial planning to ensure that you make deposits at least once a month.
There will be no nagging to transfer money into the emergency fund because the funds will be set up to automatically pay any invoices that come in.
This prevents getting distracted or saving your emergency fund from being diverted to other things.
This is what’s most important: you must invest the right amount in your fund, and also stick to your budget.
Automating your emergency fund deposit will get you into the habit of saving for a rainy day and prevent you from debts.
Channel Extra Money To Your Savings Account
There is no limit to how much money you can funnel into your savings account.
So it is not enough to rely on automating deposits to your emergency fund account. You need to take a step further and channel extra dollars to the account.
It will not matter whether the extra cash is in excess of the tax liability, gift money, cashback, or rebates from the company – just ensure you deposit an extra amount.
Similarly, once you’ve repaid a credit card or loan, channel the extra money towards your emergency fund.
At any rate, your budget won’t feel any difference. However, your emergency savings account will get a boost notice.
If you get a tax refund or bonus at work, you can save it instead. Use this money to cover you in case of emergencies, but do not rely on this as your major deposit to your emergency fund account.
Convert expenses into savings and allocate the amount to your emergency fund account. By so doing, your fund will grow quick without affecting your current budget
Identify your needs versus wants to determine which expenses can be eliminated.
Needs refer to your necessities or obligations which are essential. Whereas wants are things that you desire or wish for which are non-essential.
To cut unnecessary expenses, you need to:
- Prepare your coffee at home and bring it with you to work.
- Come to work with your lunch, rather than buying it.
- Consider taking a bus, train, or rail instead of a car.
- Forget about nonessential foods.
- Take advantage of available discounts, special and cashback offers.
The list goes on and on. It all boils down to your management habits and financial discipline.
Continue To Adjust Your Savings
Be sure to revisit your goals on a regular basis. As your circumstances change, so should your savings plan.
Because you can’t be sure how much you will spend on emergencies, it’s important to gradually increase the amount of money you save in your fund over time.
Promotion means that you can deposit more money in your savings account! Always look for new ways to ensure that your emergency fund is something you can rely on.
There’s no limit to how much you can have on your emergency fund so keep adjusting your savings to have an emergency fund just enough to cover any crisis situations.
Be sure to look over your budget for new ways to tighten the purse strings and increase the amount you’re saving.
How Much Should You Put in Your Emergency Fund?
When an emergency strikes – whether it’s a serious illness, job loss, or expensive home repair – you should be prepared to deal with the financial strain.
So, how much do you need in your emergency fund?
The truth is there’s no one-size-fits-all approach that works for everyone because how much you can deposit in your emergency fund depends on your individual circumstances.
However, most finance experts recommend having an emergency fund to cover three to six months of living expenses.
Creating a short-term emergency fund and then working for a longer-term plan could be a safer choice.
A $1,000 emergency fund would be a reasonable starting point since it would cover a variety of situations.
Then, as part of your overall financial strategy, work on increasing your emergency fund as much as you can.
If you still have debt, it’s best to focus on paying it off rather than building up a larger emergency fund.
Debt is an emergency, be it on credit cards, mortgages, or anything else. When there’s a current problem that needs to be solved, saving for a potential financial concern doesn’t make sense.
It is not necessary to have a large emergency fund. The aim is to create a fund that can be used for unforeseen expenses, paying bills, and purchasing food etc.
Where Are the Best Places to Keep an Emergency Fund?
Where do you keep your emergency fund for safety and profit? Your emergency fund should be kept separate from your other bank accounts.
You want your emergency fund to be available in the event that you need it right away.
However, you don’t want it to be too easy to access so that you’re not tempted to use these funds when they’re not needed.
Here are a couple of the best places to start saving for your emergency fund.
1. High-Yield Savings Account
It makes sense to start an emergency fund with high-yield savings account because you can usually move the money quickly if you need to.
Virtually all high-yield accounts are available from online banks.
A high-yield savings account gives you all of the benefits of a traditional savings account, but with better interest rates and more flexible terms for larger investments.
In the case of high-yielding saving accounts, you’ll earn an annual percentage yield (APY) ranging from 0.5% to 0.8%. This depends on your account size and other factors.
When opening an online savings account, it’s important to consider the rates as well as any fees, other benefits, and withdrawal restrictions.
High-yield savings accounts are available from a variety of online banks. Compare your options and choose the one that offers the features, and the rates, that are most attractive to you.
2. Money Market Account
Just like a high-yield savings account, a money market account is a type of savings account that typically earns higher interest than regular savings or checking accounts.
However, some money market accounts have debit card and checking functions, making them easier than a high-yield savings account.
Also, a higher initial deposit is required to open a money market account. Some banks have different interest rates depending on how much money you have in your account.
Not only will you earn higher interest on your money, but your funds will be secure with a money market account.
The best part about a money market account is it has both features of a savings account and a checking account. You have the benefit of an ATM card for ATM access to cash.
A money market account can be opened at most local banks as well as online banks.
You may be able to find better offers online. Since they do not have the same operating costs as conventional banks, online banks can deliver better rates.
With convenient and flexible options available to you, it’s easy to find the money market account that fits your needs.
3. Certificate of Deposit
Certificates of Deposit (CDs) are another means to keep your emergency fund. Your money is safe, grows slowly, and is easy to withdraw when you need it.
A Certificate of Deposit is a type of savings account. It pays a higher rate than the average bank savings account because the money is deposited for a certain period of time before withdrawal.
This could last anywhere from a month to five or more years. You can access your initial funds as well as any interest accrued at the end of the term.
CDs normally pay a higher rate of interest than other types of bank accounts.
Earning a higher APY is awesome, but keeping your emergency fund in a CD carries some risk.
What if an emergency arises before your CD has completely matured? You can always take money out of a CD during this period.
But you’ll almost always be charged an early withdrawal penalty. Some banks have a flat fee, while others take a percentage of your CD’s interest.
It is not ideal to keep your emergency fund in an account with higher interest that requires fees.
That’s just like gambling, in that it’s all about whether or not you’ll face any unforeseen circumstances during that time.
Although there are few CDs with no-penalty, ensure the no-penalty feature isn’t restricted to specific situations like losing your job.
Creating a CD ladder is one way to get around this. This entails switching between multiple CDs with different term lengths.
This helps you to make more money while still having access to some of your emergency funds. You could have a 3-month CD, a 12-month CD, an 18-month CD etc.
A CD account can be opened at almost any bank. Some online banks also provide CDs with higher interest rates or options. Accordingly, some CDs do no require a minimum deposit, while others do.
4. Traditional Bank Account
If saving your money in an online account or being tied up for an extended period of time does not appeal to you, you can still keep your emergency fund in a traditional saving or checking account.
A traditional bank account is the most frequently used place to keep an emergency fund.
Although with a low interest rate compared to other options, but traditional bank about is a low-risk way to save your emergency fund.
With a traditional bank account, you can access your money so quickly, and it is easy to transfer money in or out of the account.
One disadvantage of saving your emergency fund in a traditional bank account is that it can lead to withdrawals even when you’re not in an emergency situation.
To avoid this, you may need to open a new account with a different bank. This will at least add a level of difficulty, which could deter you from withdrawing funds when you aren’t in a true emergency.
5. Roth Individual Retirement Account
A Roth Individual Retirement Account (IRA) is a form of retirement account in which you pay taxes on the money you put into it, but all subsequent withdrawals are tax-free.
When you expect your taxes to be higher in retirement than they are now, Roth IRAs are the way to go.
Roth IRA can be funded with any amount at any time and has many benefits, including tax-free withdrawals and diversified investment options such as stocks, bonds, mutual funds, and exchange-traded funds.
High-yield bank accounts won’t be able to keep up with rising inflation. In the long run, putting your money into a Roth IRA would almost certainly give you more money.
However, keeping your emergency in a Roth IRA account carries the risk of losing value. But the risk of loss can be reduced by selecting reliable investment options.
You can withdraw your Roth IRA contributions without penalty at any time. But withdrawing earnings can result in tax consequences and early withdrawal penalties.
Tips on Savings, Living Frugally
Use Emergency Fund Calculator
Calculating the size of your emergency fund is essentially mathematics. It all begins with figuring out how much money you’ll need to cover your basic living expenses in a month.
From there, you can figure out how many months you’ll need in your emergency fund account. That’s where an Emergency Fund Calculator comes into play.
An Emergency Fund Calculator helps you organize your finances and reach your saving target easily.
This calculator enables you to calculate the monthly amount you should put into your Emergency Fund.
It also provides the approximate number of months and amount you need to on your emergency fund.
Having a clear goal will keep you focused on what you want to achieve with your emergency fund.
It’s not enough to tell yourself you’re just building an emergency fund. Set a realistic target for yourself, write it down, and work toward it.
You can change your goals as your situation changes. The main thing is to have a target.
The primary reason why it’s so essential to have a target in mind when saving is to ensure that you stick to your goals.
When you lose sight of what they’re trying to achieve, you are likely to derail and spend your savings on things that are not truly emergencies.
Sell Unused Items
If you are looking for a way to save for an emergency, one way to do this is to sell any items that you no longer use.
It is never easy to part with items that you have grown fond of, but by selling things that you no longer need or use you can increase your savings.
Take a look around your house and see what you have that could bring in some extra cash.
Whether it is your old cell phone, your kids’ toys, or unused kitchen gadgets, sell what you no longer use to create extra funds.
Not only will it help you save for an emergency fund, but it will also free up space at home.
You can sell things you no longer use on the local market or online such as on Facebook Marketplace, Decluttr, eBay etc.
Grow Your Income
Emergencies happen. You can’t control when, where or how they might strike, but you can prepare for them on the financial front.
This is why it is important to have multiple sources of income to ensure that you are well prepared for any emergency.
In your spare time, you could start a side hustle, get a part-time job, or start a small business.
Your emergency fund can expand rapidly if you invest the extra money in it, with the exception of some money set aside to pay taxes on the extra income.
Spend Only on Emergencies
Saving for emergencies is an important part of any financial plan. But sometimes, it can be hard to not dip into those savings when there’s no emergency.
You may be tempted to waste it on a holiday, a big-screen TV, or something else that isn’t an emergency.
However, for your emergency fund to achieve its goal, it’s important to use it only in emergencies.
There’s a reason it’s called an “emergency fund”, so don’t use it unless you really need it.
If you take money out of your account occasionally, justifying that you’ll make it up the next salary, you may be starting a bad habit that will set you back.
Here are three questions to answer when deciding whether or not to use your emergency fund:
- Is it necessary?
- Is it expected?
- How urgent is the issue at hand?
The more times you say yes, the more likely you are to use your emergency fund in that case.
When a real emergency happens, don’t be afraid to tap into your emergency fund.
It’s better than expensive options like payday loans or cash advances on credit cards.
What To Do after Saving an Emergency Fund?
There are many factors that need to be considered when deciding what to do with your hard-earned money after saving an emergency fund.
These are the key points that you should take into consideration when figuring this out:
Pay Off Your Debt
After you meet your emergency savings target you can start paying off your debt. Prioritize credit cards and high-interest debt first before focusing on other loans.
Then, take the money left over and continue saving until you reach your financial goals.
It does not only free up your monthly revenue to pay off debt but also can help boost your credit score.
Strengthening your credit score can make you eligible for loans with better interest rates.
You can pay extra without fines for most loans so you can quickly get out of the debt and save money on interest.
Also, you may have other financial objectives too, so striking a balance between debt repayment and saving is important.
Focus on Other Goals
After you’ve reached your emergency fund target, it can feel like you hit the jackpot and your work is over.
Your brain might say: “I’ve done enough and there’s no reason to keep working hard!” But the truth is that there are always other goals to set.
This is the time to focus on other goals that guarantee your all-around financial security.
Achieving financial security doesn’t mean you have to live without now, or that you have to give up on other financial goals.
While it’s great to save enough for emergencies, your future goals may require more than an emergency fund provides.
Children’s education costs can often run into the tens of thousands over time; buying a home is another major goal that can cost hundreds.
Keep setting short-term and long-term goals, and make sure you are saving for them when you invest your money.
That way, you can feel confident and worry-free as you pursue those big dreams.
Relax and Have a Little Fun
A growing emergency fund means you are prepared for life’s bill collectors. Great! Now you can relax and have a little bit of fun.
It’s not all about money. You have money here and there, in checking, savings account and even under your bed. You need to relax and have some fun.
You’re already familiar with the popular saying: “health is wealth”. Without giving proper attention to your health, your emergency fund may not save you from a critical health challenge.
Over To You
An emergency fund can be the cushion that keeps you from sinking into debt when life throws an unexpected curveball at your family.
When you have an emergency fund, you have peace of mind. Your money is on guard, just waiting to be called into action.
Whether you’re saving up for an unexpected purchase, unexpected medical bills, or looking to handle future emergencies, the peace of mind that comes from having an emergency fund is invaluable.
When emergencies strike, you don’t have to scramble to come up with the money you need, and you don’t have to turn to credit cards.
Carefully examine your situation and income to see how much you can save each month, and identify unnecessary expenses or wasted money.
Take extra steps to ensure you build up an emergency fund that can stand the test of time.
Finally, you need to relax and catch some fun with peace of mind knowing that you have nothing to worry about unforeseen circumstances.