Emergency Fund Guide: Protect Your Financial Future

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Life happens all the time, and it's hard to go about predicting when or how surprises will arrive. Despite this fact, only 41% of Americans would be able to cover a $1,000 emergency with savings.

It could be that your income is cut or you lose your job and you are unable to find a new job as quickly enough. As a result, you may find yourself struggling to pay your bills. Or it could be that your car gets a flat tire, your water heater breaks, or you need to buy an emergency plane ticket.

All of these are situations in which having an emergency fund can make all the difference. And given the unpredictability of life, it's very important to prioritize your emergency savings.

What is an emergency fund, and why is it important?

As the name indicates, your emergency fund, also known as emergency savings, is to help you weather unplanned life circumstances and emergencies. Having a stash of cash to fall back on when "life happens" means you won't have to rely on credit or rack up debt to resolve your situation.

It's the difference between having your car break down unexpectedly and leveraging cash you had already put aside for this exact purpose versus maxing out a credit card and figuring out how to pay for it later.

The latter scenario means an additional or higher credit card payment, more debt, and more money woes to worry about. And more importantly, you are now further away from your financial goals. This can be majorly demotivating.

So essentially, you can think of your emergency fund as a form of insurance. An insurance policy that you create for yourself that keeps your financial goals intact.

How is an emergency fund different from a sinking fund?

While your emergency fund acts as money to bail you out of unplanned life circumstances, a sinking fund is typically used for planned upcoming one-time or irregular expenses like routine car maintenance or vacation savings, for example.

How much emergency savings should you have?

Ideally, your goal should be to have 3-6 months of your essential living expenses in emergency savings. Before you think this is unattainable, it's important to know that this is referring to your "basic living expenses." Essentially, how much do you need at a minimum to pay for your food, housing, core utilities, and transportation? Is that number sounding more attainable?

The thing is, when everything is nice and rosy in our lives, we tend to get comfortable with spending money on "nice to have" things. However, your emergency savings really focuses on your "must-haves," which are essential to your life and survival.

Keep in mind that your emergency fund might need to be broader than just your basic living expenses. It's all about recognizing what might come up and accommodating for that as you build your fund up.

For instance, if you are driving a 10-year-old car, it's more than likely going to need a major repair soon. So you'll want to build the cost of that potential repair outside of a routine service into your savings plan.

By having a savings plan in place, what could potentially be emergencies are now mere inconveniences.

That being said, a good first milestone to set is to go about saving $1,000. This can cover most basic emergencies and is a good amount to have if you need to focus on other pressing financial goals like paying down high-interest debt.

Emergency savings if you are single

If you are single, the more you have in savings, the better, so setting a goal of at least 6 months would be wise. This is simply because, as a single person, you might not have anyone else to fall back on for financial support.

Emergency savings if you are married 

If you are married or in a relationship with a second income to fall back on, you can start with 3 months as a goal and raise it to 6 months once you reach 3 months of savings. 3 months because there are two incomes and it is less likely that you would both be out of a job for the same amount of time, for example. I will, however, stress that the more you can save for emergencies, the better. 12 months of savings would be incredible to have, especially during economic uncertainty like a recession.

How do you build an emergency fund?

Putting away 3 to 6 months of income for emergencies sounds like a lot, but if you start with saving a little, then you can save over time until you eventually reach your goal. Remember, the amount of money you are saving is to cover 3 to 6 months of your basic living expenses, so your housing, your food, and your transportation NOT your non-essentials and nice to have. If an emergency comes up, you should leverage your emergency fund and then plan to replenish it later. Here are some key ways to build your emergency fund:

Come up with the amount you need to save

To determine how much you need to save for your emergency fund, you will need to calculate 3-6 months of your essential living expenses. Remember, essential living expenses include your housing, food, medical expenses, etc. So, let's say the total amount of your essential living expenses is $2,000 a month. You calculate $2,000 by the number of months you need to save for, such as 3-6 months. This means you will need to save $6,000-$12,000 in your emergency savings account to cover your living expenses.

This may sound overwhelming, but you can ensure you can cover your basic expenses by working towards this goal. Rather than focusing on the big goal, break it down into smaller goals. For example, make it a goal to save your first $1,000 towards your emergency fund. This is an easier goal to attain, and eventually, you will build up your emergency savings to the needed amount.

Build saving into your budget

The easiest way to build your emergency savings is to make saving money a part of your budget. Make it a goal to save a certain percentage of your pay or a set amount each week towards your emergency savings. For instance, you could save 10-15% of your pay or a set amount of $50 every week. Another simple way to start saving is to start living below your means. By including savings into your budget, you will quickly bulk up your emergency fund and be prepared for unexpected events.

Automate your finances

To prevent the temptation of spending money rather than saving it, you should automate your finances. Automating your finances means you set up paying your bills and savings deposits to be paid automatically. For example, you can set up automatic deposits through your employer into your emergency savings account. You can also set up automatic transfers through your bank to ensure you deposit into your emergency fund regularly. Automating your finances can prevent money mishaps and help you save money easier.

Save refunds and bonuses

It's easy to blow through tax refunds and pay bonuses, but that is money that can increase your emergency savings quickly. Rather than shopping, deposit that additional income into your emergency fund. Think of it as an ace in the hole for when life throws you a bad hand, such as an unexpected job loss. Saving your refunds and bonuses can prevent you from racking up credit card debt and having to borrow money from friends or family.

Where should you keep your emergency savings?

Your emergency fund should be easily accessible and liquid. This way, you can get to it when you need it without having to wait or take a liquidation hit. Keeping that in mind, don't tie your savings up in the stock market or in real estate. An interest-bearing savings account or a certificate of deposit are good places to store your emergency money.

Is spending your emergency savings tempting? Consider setting up automatic deposits to a bank account at a different bank not connected to your main checking account. Also, skip the checks and debit card. Make it as easy as possible to avoid temptation.

In closing

Having an emergency fund is essential and should be part of everyone's overall financial plans. Make saving for an emergency fund one of your top 10 money moves to make this year! The last thing you want is to be set back financially by not being prepared to handle things when life happens. So get starting with saving for your fund today!