The thing about emergencies is that they arrive at the worst possible time. You just drained your checking account to pay the rent, for example, and then you rear-end someone at a stoplight. Or, you finally pay off your credit card, only to find your dishwasher leaking and destroying your kitchen floor.
In these moments, a stocked emergency fund can ease your stress and keep your finances healthy. Read on to learn what an emergency fund is, plus essential tips for building and managing your money reserves like a pro.
What is an emergency fund?
An emergency fund is a store of cash that’s earmarked for surprise expenses. You keep the money on deposit, but ignore it until something unexpected happens, such as:
- Job loss
- Work furlough
- Illness or injury
- Sick or injured pet
- Car accident
- Damage to your home
Each of these circumstances comes with an income loss or increased expenses. If you lose your job, for example, emergency fund cash can supplement your unemployment income. That keeps the bills paid until you find a new opportunity. Or if your dog gets sick, you can pay the vet bills out of your emergency fund — rather than using expensive credit card debt.
More than 60% of Survey Junkie members already have an emergency fund, and saving more for one is their top financial goal, ahead of retirement saving, debt repayment, padding a vacation fund, and saving for big-ticket items.
Why now is the time to save
Generally, now is always the best time to save to an emergency fund. Why? Because bad financial surprises are unpredictable. And so you have to assume you may need extra cash at any moment.
But in today’s economic climate, there are added reasons to start saving now. These include:
- High interest rates: Cash savings rates are stretching above 3% APY. You want to take advantage of those high rates because they won’t be around forever. Just a few years ago, you were lucky to get 0.50% APY on your cash deposits.
- Looming recession: Many economists predict a mild U.S. recession in 2023. Recession increases the chances of job layoffs. You want to be prepared for that possibility.
The benefits of an emergency fund
Having money available for unexpected expenses delivers serious benefits, including improved financial strength, peace of mind, and vital experience practicing financial discipline.
Financial strength. First and foremost, you are stronger financially with cash on hand. When you have the money to absorb emergencies, you spend less on credit cards. That spares you from interest fees and other bank charges down the road.
Peace of mind. You’ll also be confident you can handle a huge variety of financial situations. That peace of mind is priceless. Imagine facing the possibility of job loss. With no extra money available, you will also worry about losing your home or ruining your credit. A good emergency fund balance minimizes your stressors in those tough situations.
Financial discipline. Building a reasonable emergency fund balance takes time and discipline. Flex those muscles long enough and they become a habit. And that habit of saving is the key to achieving any financial goal.
How much money should you have in your emergency fund?
Experts recommend an emergency fund balance that’s enough to cover three to six months of your living expenses. If you don’t know your living expenses, start by adding up your annual net income. Divide that number by 12, and then adjust as needed. Common adjustments include:
- Adding expenses you charge on credit cards. Credit cards allow you to spend more than you make. For a true sense of your living expenses, add back what you charged to your cards.
- Adding back expenses that are deducted from your paycheck. Retirement contributions and health care expenses are the big ones.
If you make an average salary of $60,000 annually, you probably spend about $48,000 a year after taxes. In that case, you would target a minimum emergency fund balance of $12,000 to $24,000.
Surprised by the size of that range? You’re not the only one. While 69% of Survey Junkie members contribute regularly to savings, more than one-third (38%) have less than $1,000 on deposit. Still, some are hitting and surpassing those balance thresholders. The table below shows the breakdown.
|Savings Balance||Percentage of Survey Junkie Members|
|Less than $1,000||38%|
Table data source: Survey Junkie.
How to build an emergency fund
Knowing you need an emergency fund is one thing. Understanding how to create that fund is another. To get you going quickly on this new phase of your financial evolution, here’s an easy step-by-step plan for building up your money reserves.
First, set a starting goal. This could be the three months of living expenses balance, but it doesn’t have to be. If you’re not in the habit of saving yet, set your sights on a lower number — say $1,000.
Second, determine how much you can save. If you follow the 50/30/20 budget practice, 20% of your budget is allocated to savings and debt paydown. Most of that 20% is probably earmarked for debt paydown and retirement. Still, you might allocate 5% for your emergency fund. On a $48,000 annual budget, that’s $200 a month.
The last step is to set a timeline. If your initial goal is $1,000 and your savings budget is $200, your timeline is five months. After you reach that first goal, set another one and repeat the process.
Note that you don’t have to set a monthly savings goal. A daily, weekly, or annual goal may work better for you. It mostly depends on how often you get paid and your personal spending habits. Across the Survey Junkie community:
- 8% set daily goals
- 31% set monthly goals
- 13% set yearly goals
Sadly, 48% of Survey Junkie members don’t set savings goals.
Implementing your plan is easy if you use automation. Set up automatic transfers from your checking account to your savings account. Time those transfers to happen the same day your employer deposits your paycheck. 68% of Survey Junkie members contribute to their emergency fund on a regular basis.
3. Increase your income
Adjusting to your new savings practice is easier if you find ways to increase your income. A simple option is to join the Survey Junkie community. Do so to earn money for sharing your feedback on reputable brands and products you may already use.
Other side hustle ideas include:
- Freelancing on gig sites like Fiverr
- Selling handmade crafts on Etsy
- Transcribe documents from home
- Tutor remotely to students around the world
You can funnel the extra income into your checking account. That will help relieve the sting of those automatic transfers into your emergency savings.
4. Monitor progress
Check your progress against your goal every three months. Even if you’re saving automatically, this check-in is important. Give yourself a few minutes to feel proud of what you’ve accomplished. Think of your growing financial strength and how it will benefit you going forward.
If you’re falling behind on your plan, uncover why. It’s usually one of two things: bad luck or poor decision-making.
Be honest with yourself here. You might have trouble controlling your spending. In that case, try working on a cash budget. Once your cash runs out, that’s your cue to stop spending money.
5. Avoid new debt
While you are working to live into a new budget, avoid new debt. New debt masks overspending and makes it harder to save. Whatever funds you had budgeted for the emergency fund may have to go to the credit card company instead.
Where to keep your emergency fund
The normal practice is to keep your emergency fund in a savings account where you earn a competitive interest rate. In the first half of 2023, a competitive interest rate is something more than 2.5%.
It’s also smart to keep the money in a savings account that’s not too accessible. You want it linked to your checking account — but consider using a different bank. This way, money transfers between your two accounts aren’t instant. If access to the cash takes a few days, you’re less likely to spend your emergency savings on an impulsive purchase.
When to use your emergency fund
Plan on tapping your emergency savings for sudden, unexpected changes in your income or expenses. You might use the money to cover your rent after a work furlough. Or it might pay your insurance deductible after a car wreck.
Once you have $10,000 or more saved to your emergency fund, you may want to use some of it to repay high-rate debt. Alternatively, you could pause your emergency fund deposits temporarily — and redirect that money to your debt accounts instead.
Do not use your emergency fund to take a nice vacation or buy yourself a new car.
Those items are separate savings goals. You can pursue them in the same way you save for emergencies — but using different funds. For example, you might budget $200 monthly for your emergency fund and, separately, $100 monthly for your annual vacations.
Ready for anything with emergency savings
With money on hand, you can manage through financial upsets without lingering damage. Even better, the process of building an emergency fund teaches you critical money management skills. If you can set a goal and save over time to achieve it, you have the know-how to repay debt, save for a down payment on a house, send your kids to college, and retire comfortably.
It’s exciting to have that know-how. Today you are saving for emergencies. And tomorrow? Who knows. You may be working towards retiring young with a full seven figures in the bank.