Why You Need an Emergency Fund and How to Build One

by | Apr 23, 2020

No matter where you are in your financial journey, having an emergency fund is crucial to achieving financial freedom. Building some emergency savings should be your top priority in terms of financial goals.

Emergency funds are exactly what they sound like: money stored away in a savings account (preferably high-yield, more on that later) in case you have an unexpected expense. In today’s uncertain climate with COVID-19 disrupting the economy and how we live our daily lives, an emergency fund is even more necessary for stability.

 

The Benefits of Having an Emergency Fund

Saving money and putting it away isn’t always easy. But going into debt or withdrawing from your retirement account early can have long-term consequences on your financial health. When you have money saved for trouble times: 

1. You won’t need to go into debt for an emergency 

Approximately 30% of Americans would need to borrow money in order to cover a $1,000 dollar emergency. More likely than not, they would be paying interest on that loan resulting in them paying much more than the principal amount. 

2. You will have money to cover unexpected medical bills 

Many Americans that do not have medical or dental insurance. They might also hold off on seeing a provider due to the high cost of office visits, co-pays, and medications. Having an emergency fund means you’ll never have to worry about putting your health at risk due to financial restraints. 

3. You can continue paying bills in case of job loss 

This is a reality for many Americans these days. With the news constantly predicting dire unemployment rates due to the pandemic, people are wondering how long their jobs will be secure. For those who have already lost their jobs, the question of how long will their emergency fund last becomes the main discussion. Even if you have a stable job, having an emergency fund is critical in the event you need to resign from your current job rapidly due to a toxic work environment.

4. You can repair an unexpected house or car breakdown

Let’s be honest. Buying a new set of tires easily costs upwards of $800 depending on the type of car you have. Need a plumber due to a leaky pipe? Several hundred dollars for it to be fixed is the best-case scenario. Having an emergency fund can help you take care of that.

5. Peace of mind 

Having money set aside for emergencies helps give you peace of mind that you were prepared for the event to happen. Having money in the bank makes everything less stressful. And knowing that you won’t need to withdraw money from other funds such as your retirement account, a college savings account for your children, and other investments that are earning value. 

Emergencies wait for no one and can happen in the blink of an eye. Not going into debt, or more debt, due to an expected expense is a real bonus. People with some financial cushion during an emergency show less stress during an emergency and can more productively handle the situation.

How Much Should You Have in an Emergency Fund? 

Basic emergency fund advice says you should save $1,000 in your emergency fund and then proceed to pay off high-interest debt. If you have large amounts of credit card debt, $1000 is a good baseline.

However, our current pandemic demonstrates that $1,000 just doesn’t cut it. In a global emergency — especially one that’s likely both a long-term financial and health crisis — that $1,000 will go quickly. It’s not enough to give you actual financial security in case of an emergency.

Even if you have a mountain of credit card debt, aim for at least 3 months of living expenses in your emergency fund before you move on to the other steps. If you haven’t started your emergency fund— now is the time. Don’t do anything else before making a plan to set up an emergency fund. 

Don’t know exactly how much you spend each month? Take out a pen and paper or use an app (like Charlie!) to help you figure out your spending habits. Emergency funds are meant to cover NECESSARY living expenses. This includes housing, utilities, food, insurance, and other things needed for daily living. 

At a minimum, aim to save 3-6 months — or ideally, 6-9 months — of living expenses set aside for emergencies. If you’re a business owner, it might be wise to have a personal emergency fund, as well as a business emergency fund. 

If you have started your emergency fund already (good for you!) but you don’t have it fully-funded, now’s the time. Do everything you can to prep now.

It seems obvious but bears repeating: an emergency fund is only for emergencies. Pretend the money doesn’t exist unless an emergency comes up — such as job loss, medical emergency, or an unexpected car repair. Keeping your emergency fund in another account means it’s out of sight and out of mind —  making it easier to forget its existence. 

How you can start building your emergency fund:

1. Automate money going into a savings account every month. 

This is something that can be easily done through online banking or your payroll platform at work. If you have direct deposit and are also a W2 employee, you can allocate part of your paycheck to go directly into a savings account so you don’t need to remember to automate it yourself. The savings, especially if you put it away through a high-yield savings account, can go a long way when you include interest. 

2. Take windfalls of cash and put them towards your emergency fund. 

Tax refunds, money saved from negotiating recurring bills, and salary increases should be funneled into your emergency fund to speed up the savings process. This includes your stimulus check if you can cover your current month’s bills. No one knows how long this economic uncertainty will last so it’s best to be as prepared as possible. 

3. Make sure it’s in a high-yield savings account. 

If your money is just going to sit there — which is what we want — it may as well be working harder for you. The average bank will give you .01% on your money aka pennies. Online banks tend to offer higher rates on their savings accounts because they have less overhead due to not having a brick and mortar shop. This bank account gives you a 1.7% interest rate back on your deposit. 

During times of uncertainty, having the financial peace-of-mind an emergency fund brings is crucial. Do everything you can to fast-track your progress, and fully-fund your emergency savings goal. Life doesn’t stop for anything, especially a pandemic. You’ve got this.

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