Emergencies can come out of nowhere. When they do, a healthy emergency fund can make all the difference in the world. Setting aside enough cash to cover three to six months’ worth of expenses might seem like a daunting task, but it’s actually pretty simple. Whether your savings account balance is $0 or you already have a head start on saving, here’s a quick guide showing you how to start an emergency fund.
7 Steps to Start an Emergency Fund
1. Set a Budget
Start by doing some basic budgeting to figure out your cash flow and monthly expenses. A budget can serve as a financial roadmap, helping you determine how much money you can safely allocate for various accounts.
For example, suppose you have an average monthly income of $3,000. Of this, $1,200 may go to rent, $600 toward food, $150 to utilities, and $100 to debt payments, like student loans or credit cards. This leaves you with $900 left over to spend, save, and invest freely. You can use some of that cash to seed your emergency fund.
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2. Open an Emergency Account
Once you have a basic idea of your budget, the next step is to set up a separate bank account dedicated entirely to emergency savings.
Here are some of the best places to park your emergency fund:
- Checking account: Checking accounts typically offer low-interest rates. However, the best checking accounts give you the flexibility to move money around as needed without transaction limits.
- Money market account: This interest-bearing account offers the flexibility of a checking or savings account with a higher interest rate. You can typically write a limited number of checks against your money market account.
- High-yield savings account: A high-yield savings account (HYSA) is an online savings account with interest rates that run roughly 20 times more than traditional checking or savings accounts, making them an ideal vehicle for an emergency fund.
As you compare accounts, keep in mind that some banks offer cash bonuses when you open a new account. A bank bonus could help jumpstart your savings.
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3. Establish Your Emergency Fund Goal
Your next step is to figure out how much money you should have stored away. Check out the Millennial Money Emergency Fund Calculator below to learn how much is right for you.
4. Start Small
Your emergency fund will take time to build. While it’s good to know how much you need to save overall, give yourself small attainable savings goals to start with.
When you meet these goals, you’ll be motivated to keep saving out of habit and create bigger goals.
The key is to contribute to your emergency fund regularly, no matter what. Set aside a certain amount of money and choose a frequency for your contributions. After a while, your new financial habit will start to stick.
To fast-track, your emergency savings goal, put extra money from a birthday gift or a tax refund towards your fund.
5. Put Your Savings on Auto-Pilot
Automating your savings is a great way to keep yourself on track and build up your emergency fund.
Have part of your paycheck deposited into your savings account. You may be able to do this with a direct deposit from your employer, or you can schedule an automatic transfer into your savings account around payday.
Some bank accounts also have a round-up feature, where purchases are automatically rounded up to the next dollar and the spare change goes into savings.
6. Keep It Balanced
Prioritizing your emergency fund is a great personal finance move, but you need to balance your savings goals with your debt repayment strategy.
If you have toxic high-interest debt from loans or credit cards, you should take a level approach to your savings and consider the cost of interest charges.
This might look like setting a smaller savings goal as you work to pay down your debt, then increasing your emergency fund contributions as you go.
7. Invest for Growth
Don’t contribute too much to your emergency fund and lose sight of your long-term financial goals. Once you’ve reached your emergency fund goal, start investing for long-term growth, too.
Young investors should put money into long-term retirement accounts like individual retirement accounts (IRAs), Roth IRAs, and 401ks. You may also want to explore using a Health Savings Account (HSA) if you’re eligible.
In addition to offering tax benefits, these savings accounts collect compound interest over time, giving you significantly more when you retire. You can also invest your HSA funds in the stock market for additional gains.
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Why You Need an Emergency Fund
Here are a few reasons why having an emergency fund is important:
- Cover basic expenses: An emergency fund can be used to fund a limited budget for basic necessities like food, shelter, utilities, and fuel. It can also be used to pay for medical bills or other accidents.
- Avoid financial setbacks: An emergency fund can prevent you from liquidating investments or selling assets like a car or your home to survive during a difficult time. It can also keep you from racking up credit card debt unnecessarily.
- Pay health bills: Lengthy hospital stays, ambulance rides, and medication or therapy can cost tens of thousands of dollars. Estimates are that between a quarter and a half of all bankruptcies involve significant medical expenses. Setting aside money ahead of time can help.
How Much to Save in Your Emergency Fund
Eventually, you should have set aside enough money to cover three to six months of living expenses in your emergency savings fund.
But your specific savings goals should be based on your income, expenses, and debt.
Rather than completely replacing your paycheck, focus on saving enough to cover the essentials—your rent or mortgage, loan payments, food, gas, and utilities.
And keep in mind that building up an emergency fund doesn’t happen overnight. Take time and build your way up from small savings goals to more significant ones.
Where to Put Your Emergency Funds
As a refresher, you can put your emergency savings in a number of places, but one of the best spots is a high-yield savings account from an FDIC-insured bank. These accounts give you easy access, security, and competitive interest.
I recommend opening a savings account with an online bank. These banks don’t have brick-and-mortar locations, but they offer significantly higher APY than traditional banks, charge fewer account fees, and have top-notch mobile banking features.
Frequently Asked Questions
What is an emergency fund?
An emergency fund — or rainy day fund — is a special stash of cash that you stock away for unexpected expenses. For example, you might use an emergency fund to cover car repairs after an accident or to cover living expenses after a job loss or illness rears its ugly head.
Since it’s essentially like insurance against the curveballs life will throw at you, putting together an emergency fund is one of the smartest financial decisions you can make in life.
When should you use emergency savings?
You should use emergency savings for unexpected bills or payments, like a broken down car, job loss, home repair, or medical emergency. Turn to your emergency savings before tapping into credit cards or touching your investments.
You shouldn’t use your emergency savings for routine monthly costs.
Should you use retirement savings for emergencies?
Using retirement savings from a 401k account or IRA is generally not a good idea. It can come with a stiff financial penalty, and you’ll have to pay taxes on the money you withdraw early.
The best approach is to treat that money like it doesn’t exist and focus on other ways to plan for emergencies. Diversify your income to bring in more cash to set aside, and put money into high-performing savings accounts and the stock market.
Should you put emergency savings in the stock market?
Since the stock market is much more volatile than secure savings accounts, you shouldn’t put your emergency fund there. Don’t invest money you can’t afford to lose. Whenever you put money into the stock market, make sure you have enough cash in savings to cover emergency expenses.
You can invest your emergency fund if you’re strategic about it, but it’s important to understand the risks.
How can you prevent tapping into emergency savings?
Diversify your income to avoid tapping into emergency savings during a situation where you lose your income. One way to do this is to start a side hustle or a side gig. By doing so, you will expand your sources of income, which can help reduce the risk of losing your job.
The Bottom Line
Life is unpredictable. At some point, you may find yourself in a situation where you are unable to bring in money for whatever reason. You might also find yourself facing an unforeseen expense you didn’t budget for.
By starting an emergency fund and linking it to your bank account, you can get peace of mind knowing you have a safety net to help cover short-term expenses during an emergency situation.
At the end of the day, financial security is all about planning ahead. By starting an emergency fund, you will be much better off down the line. And once your fund is squared away, you can start thinking about other ways to invest your money and achieve financial independence.
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