How to build an emergency fund: Essential Guide
LAST UPDATED: July 10, 2023 | By Conrad Golly
Did you know that 40% of Americans can’t cover a $400 unexpected expense? That’s why building an emergency fund is crucial. Building an emergency fund is an essential step in securing your financial future.
It’s a safety net that can help you cover unexpected expenses, such as medical bills, car repairs, or job loss. Knowing how to build an emergency fund and what it is doesn’t have to be hard.
How to build an emergency fund, in short, A good rule of thumb is to save at least three to six months’ worth of living expenses. This means that if your monthly expenses are $2,500, you should aim to save between $7,500 and $15,000 in your emergency fund.
What is an Emergency Fund?
An emergency fund is a separate account with a sum of money set aside for unexpected expenses or financial emergencies. It’s a safety net that can help you avoid high-interest debt or dipping into your retirement savings when unexpected expenses arise.
Why Build an Emergency Fund?
An emergency fund is a savings account that you set aside for unexpected expenses. It’s a safety net that can help you avoid debt and financial stress when life throws you a curveball. Here are some reasons why you should build an emergency fund:
Unexpected Expenses
Life is unpredictable, and unexpected expenses can pop up at any time. A medical emergency, a car repair, or a job loss can all create financial strain. Without an emergency fund, you may be forced to rely on credit cards or loans to cover these expenses, which can lead to high-interest debt and financial stress.
Having an emergency fund can give you peace of mind knowing that you have a financial cushion to fall back on. It can help you cover unexpected expenses without having to rely on credit cards or loans. This can help you avoid debt and financial stress, and allow you to focus on getting back on your feet.
How Do I Build an Emergency Fund?
Building an emergency fund is one of the most crucial steps you can take towards securing your financial future. It can help you avoid debt and financial stress when unexpected expenses arise. Here are some easy steps to get your emergency fund started:
7 Easy Steps to Get Your Emergency Fund Started
- Determine how much you need: The general rule of thumb is to have at least three to six months’ worth of living expenses saved up. Use your monthly budget as a starting point to calculate your expenses.
- Set a savings goal: Once you know how much you need, set a savings goal and create a timeline for achieving it. Break it down into smaller, manageable chunks to make it less daunting.
- Open a separate savings account: Keep your emergency fund separate from your other savings and checking accounts. This will help you avoid dipping into it for non-emergency expenses. (See M1 Finance Review)
- Automate your savings: Set up automatic transfers from your checking account to your emergency fund savings account on a regular basis. This will make saving easier and more consistent.
- Cut back on expenses: Look for ways to reduce your expenses and redirect the savings towards your emergency fund. Consider cutting back on non-essential items like dining out or entertainment.
- Increase your income: Consider taking on a side hustle or finding ways to increase your income. Redirect the extra income towards your emergency fund.
- Stay committed: Building an emergency fund takes time and discipline. Stay committed to your savings plan and avoid dipping into your emergency fund for non-emergencies.
Where Do I Put My Emergency Fund?
Congratulations! You’ve decided to start building your emergency fund. Now, the question is, where should you keep it? Your emergency fund should be easily accessible, safe, and earn interest. Here are a few options to consider:
Savings Account
A savings account is a popular choice for emergency funds. It is a low-risk option, and your money is easily accessible. You can withdraw your money at any time without penalty. However, traditional savings accounts offer lower interest rates than other options.
High-Yield Savings Account
A high-yield savings account is similar to a traditional savings account, but it offers higher interest rates. The interest rates are typically higher than traditional savings accounts, but they may require a higher minimum balance. Some online banks offer high-yield savings accounts with competitive interest rates and no minimum balance requirement.
Money Market Account
A money market account is a type of savings account that usually offers higher interest rates than traditional savings accounts. They are FDIC-insured, which means your money is safe. However, money market accounts may require a higher minimum balance and have limited transactions per month.
Cash
Keeping your emergency fund in cash is not recommended, but it is an option. Cash is easily accessible, but it is not safe. If your cash is lost or stolen, you cannot recover it. Additionally, cash does not earn interest, so your money will not grow.
Online Bank
Online banks are becoming more popular for your emergency savings and funds. They offer high-yield savings accounts with competitive interest rates and no fees. Online banks are accessible 24/7, and you can easily transfer money to your checking account when needed.
M1 Finance
M1 has a High-Yield Savings Account? It’s a great option for saving money with a 5% APY rate. That’s a pretty sweet deal! You can open an account with no minimum balance and no monthly fees. Plus, it’s FDIC-insured, so your money is safe.
To get started, you need an M1 Finance account. Once you have that, you can open a savings account and transfer funds from your M1 Spend account or an external bank account. And if you’re an M1 Plus member, you can earn even more benefits like cash-back rewards and lower borrowing rates.
The M1 High-Yield Savings Account is a flexible and accessible option for building an emergency fund or saving for other financial goals.
Building Your Emergency Fund
An emergency fund is an essential part of your financial plan. It provides a safety net for unexpected expenses, such as medical bills, home repairs, or loss of income. Building an emergency fund can seem daunting, but it doesn’t have to be. By making saving automatic, finding extra money, and exploring side hustles, you can build your emergency fund over time.
Making Saving Automatic
One of the easiest ways to build your emergency fund is to make saving automatic. Set up automatic transfers from your checking account to a high-interest savings account each month. This way, you won’t have to think about saving, and it will become a habit.
Finding Extra Money
Finding extra money to put towards your emergency fund can be challenging, but it’s not impossible. Start by looking at your monthly expenses. Are there any areas where you can cut back, such as transportation or food? Consider negotiating bills, like cable or internet, to save money. You can also look for windfalls, such as tax refunds or bonuses, to put towards your emergency fund.
Side Hustles
One way to do it is to explore some side hustles! There are tons of opportunities out there to earn extra cash, like freelancing, selling stuff online, or even pet-sitting. Find something you enjoy doing and turn it into a side hustle. Not only will you make some extra dough, but you’ll also pick up some new skills along the way.
Remember, building up your emergency fund takes time, so don’t get discouraged if it’s not growing as fast as you’d like. Start small and gradually increase your savings over time. Having a rainy-day fund will give you peace of mind knowing that you’re ready for any financial emergencies that might come your way.
And with inflation on the rise, according to the U.S. Bureau of Labor Statistics, having a well-funded emergency fund is more important than ever. So pay yourself first and watch that emergency fund grow!
Emergency Fund FAQs
What Is An Emergency Fund?
An emergency fund is a savings type account that’s dedicated to covering unexpected expenses, such as medical bills, car repairs, accidents, or job loss.
Why Do I Need It?
An emergency fund can help you avoid debt and financial stress when unexpected expenses arise. It can also provide a sense of security and peace of mind.
How Much Do I Need In It?
The general rule of thumb is to have at least three to six months’ worth of living expenses saved up. However, the amount you need may vary depending on your individual circumstances.
How Do I Build It?
To build an emergency fund, determine how much you need, set a savings goal, open a separate savings account, automate your savings, cut back on expenses, increase your income, and stay committed to your savings plan.
Where Should I Keep It?
Keep your emergency fund separate from your other bank accounts, savings and checking accounts. Consider keeping it in a high-yield savings account or money market account for easy access.
When Should I Use It?
Use your emergency fund only for true emergencies, an emergency expense such as unexpected medical bills or car repairs. Avoid using it for non-emergency expenses or discretionary spending.
How to Use and Replenish Your Emergency Fund
Examples of situations when you should use your emergency fund
Life is unpredictable, and emergencies can happen at any time. It’s important to have an emergency fund to cover unexpected expenses. Here are some examples of situations when you should use your emergency fund:
- If your car breaks down and needs expensive repairs
- If you have a medical emergency and need to pay for unexpected medical bills
- If you lose your job and need to cover your rent or mortgage payments
- If your home needs urgent repairs due to damage from a natural disaster or other unexpected event
Tips for using your emergency fund wisely
While it’s important to have an emergency fund, it’s also important to use it wisely. Here are some tips for using your emergency fund:
- Only use your emergency fund for true emergencies
- Avoid using credit cards to cover unexpected expenses
- Try to negotiate payment plans with creditors instead of using your emergency fund to pay off debt
- Use your emergency fund to cover basic necessities like rent, food, and utilities
Steps to take after using your emergency fund
If you’ve had to use your emergency fund, it’s important to replenish it as soon as possible. Here are some steps you can take to rebuild your emergency fund:
- Start by creating a budget and cutting back on unnecessary expenses
- Consider taking on a side hustle or finding ways to increase your income
- Set up automatic transfers to your emergency fund to make saving easier
- Use windfalls, like tax refunds or bonuses, to boost your emergency fund
- Consider negotiating a raise with your employer and using the extra income to build up your emergency fund
Strategies for rebuilding your emergency fund
It’s recommended to have at least a six-month emergency fund to cover unexpected expenses. Here are some strategies for rebuilding your emergency fund:
- Pay yourself first by setting aside a portion of your income each month for your emergency fund
- Consider opening a separate savings account specifically for your emergency fund
- Use automatic transfers to make saving for your emergency fund a priority
- Find ways to increase your income through a side hustle or by negotiating a raise with your employer
Remember, life is unpredictable, but having an emergency fund can help you weather unexpected financial storms. By using your emergency fund wisely and taking steps to rebuild it, you can be better prepared for whatever life throws your way.
Common Mistakes to Avoid When Building an Emergency Fund
Building an emergency fund is an essential part of financial planning. However, there are some common mistakes that people make when trying to save for unexpected expenses. Here are a few things to avoid when building your emergency fund:
Mistake #1: Not having a budget
One of the biggest mistakes people make when building an emergency fund is not having a budget. Without tracking your income and expenses, it’s hard to know how much you can realistically save each month. Make sure to create a budget that includes all of your monthly expenses, such as rent, utilities, groceries, and transportation. Once you have a budget, you can determine how much you can save each month towards your emergency fund.
Mistake #2: Relying too much on credit cards
Another common mistake is relying too much on credit cards to cover unexpected expenses. While credit cards can be a useful tool, they should not be your only source of funding in an emergency. If you don’t have an emergency fund, unexpected expenses can quickly lead to credit card debt, which can be difficult to pay off. Instead, try to save at least three to six months’ worth of living expenses in an emergency fund.
Mistake #3: Not paying off debt first
If you have high-interest debt, such as credit card debt or personal loans, it’s important to prioritize paying it off before building your emergency fund. While it’s important to have savings for unexpected expenses, paying off high-interest debt should be your first priority. Once you’ve paid off your debt, you can focus on building your emergency fund.
Mistake #4: Not automating your savings
Many people struggle to save money because they forget to do it. One way to avoid this is to automate your savings. Set up a direct deposit from your paycheck into your emergency fund each month. This way, you won’t have to remember to transfer money into your savings account, and you’ll be less likely to spend the money on other things.
Mistake #5: Using your emergency fund for non-emergencies
Finally, one of the biggest mistakes people make is using their emergency fund for non-emergencies. Your emergency fund should be reserved for unexpected expenses, such as medical bills or car repairs. It should not be used for things like vacations or shopping sprees. If you find yourself dipping into your emergency fund for non-emergencies, it’s time to re-evaluate your spending habits and create a separate savings account for those unplanned expenses.
How to Stay Motivated When Building an Emergency Fund
Building an emergency fund is an essential part of any financial plan. However, it can be challenging to stay motivated when you’re trying to save money for an emergency fund. Here are some tips to help you stay motivated:
Set Realistic Goals
Setting realistic goals is essential when building an emergency fund. Don’t try to save too much money too quickly, or you’ll end up feeling overwhelmed and discouraged. Instead, set small, achievable goals that you can reach in a reasonable amount of time. For example, you could aim to save $500 in three months or $1,000 in six months.
Make Saving Automatic
One of the easiest ways to stay motivated when building an emergency fund is to make saving automatic. Set up a direct deposit from your paycheck into a separate savings account specifically for your emergency fund. This way, you won’t have to think about saving more money each month, and you’ll be less likely to spend it.
Track Your Progress
Tracking your progress is an excellent way to stay motivated when building an emergency fund. Create a spreadsheet or use a budgeting app to keep track of how much money you’ve saved each month. Seeing your progress can help you stay motivated and give you a sense of accomplishment.
Celebrate Your Successes
When you reach a savings goal, celebrate your success! You don’t have to spend a lot of money to celebrate. Treat yourself to a small reward, like a movie night or a dinner out. Celebrating your successes can help you stay motivated and make saving money more enjoyable.
Find an Accountability Partner
Having someone to hold you accountable can be a great way to stay motivated when building an emergency fund. Find a friend or family member who is also trying to save money and make a pact to hold each other accountable. Check in with each other regularly to share your progress and offer support and encouragement.
Verdict: How to build an emergency fund?
Congratulations! You have taken the first step towards building an emergency fund. By now, you have learned what an emergency fund is and why it is important to have one. You have also learned how to build an emergency fund and how much money you should save.
But building an emergency fund is not enough. You also need to know how to use it. Your emergency fund should only be used for unexpected expenses that you cannot cover with your regular income. It is not for vacations or other non-essential purchases.
Final Tips and Advice for Building and Using an Emergency Fund:
- Keep your emergency fund in a separate savings account that is easily accessible but not too easy to spend.
- Set a goal to save three to six months’ worth of living expenses.
- Make saving a habit by automating your savings.
- Re-evaluate your emergency fund regularly and adjust as necessary.
- If you do have to use your emergency fund, replenish it as soon as possible.
Remember, emergencies can happen at any time. Building an emergency fund is not a one-time task but an ongoing process. By following the tips and advice provided in this article, you can be better prepared for unexpected expenses and have peace of mind knowing that you have a safety net.
So start building your emergency fund today and take control of your financial future!
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