What Is an Emergency Fund?
An emergency fund usually consists of a savings account that’s put aside to help pay for unexpected financial surprises. Because life can throw you a curve ball every once in a while, emergency funds are key to help you continue forward — toward your financial goals.
But do you know how much emergency money you need? We’ve got some great tips to help you calculate emergency funds based on your income, budget and long-term financial objectives.
The goal of an emergency fund is to give you access to the money you need to move through an emergency or unexpected expense with ease. It not only helps relieve the financial burden, but you’ll find real peace of mind too once it’s set up. An emergency fund is a great layer of financial protection for what matters most in your life, especially during uncertain times.
How Much Money Should Be in an Emergency Fund?
In most cases, emergency funds should pay for every expense in your budget for three to six months, at a minimum. To calculate the emergency funds you’ll need, multiply your monthly budget by the number of months you’d like to have in reserve. You can also use an emergency fund calculator to help estimate what this amount should be.
How to Build an Emergency Fund For the Unexpected
The best way to create an emergency fund is to start a new savings account at your bank. A modest deposit of even a few hundred dollars can help motivate you to put cash aside every month. Don’t have one set up? Here’s how to start an emergency fund savings account:
Automate a monthly savings transfer
Schedule a monthly transfer of funds from your checking account to your emergency fund savings account. This can be accomplished by logging into your bank account online or through your bank’s smartphone app and setting up a recurring transfer.
Deposit your IRS tax return into your emergency fund
In many households, the tax refund is one of the larger sums of cash received over the course of the year. If you can’t put the entire amount towards your emergency savings, do your best to earmark a large percentage of that windfall towards your rainy-day fund.
Build a budget and stick to it
By getting serious about savings, you just might find a surplus of funds each month. And those additional small monthly contributions can add up quickly over time. By charting exactly how much cash is moving in and out, you’ll be well on your way to meeting your one-year financial goal.
Sock away your cash
Make a habit of socking away a few spare dollars from your wallet each month and hide that money away until you can deposit it at the end of the month.
Install a budgeting app on your smartphone
One great way to understand monthly spending is to use a budgeting app. Also available online, services like Mint and YNAB (You Need a Budget) can really shed light on how to free up funds by spending less and saving more.
Use an emergency fund calculator
Calculators like those offered for free via MoneyUnder30 and NerdWallet crunch the numbers after you input a few basic details about your monthly expenses. How do you calculate an emergency fund ratio? Let the calculator do it for you. You’ll receive a savings figure based on the data you input. The rest is up to you.
Take your time when building your emergency savings fund
Ideally an emergency fund should contain enough financial savings to cover your major expenses for six to nine months. If you’re just starting a savings account and that amount seems challenging, that’s okay. Even that first dollar you put aside is a step in the right direction! Take your time and be proud of the effort you’re making.
Explore how your expenses affect your emergency savings fund
List your expenses. Look at your regular fixed and fluctuating expenses and estimate how much you spend monthly. This gives you a target amount of savings for your emergency fund. Things to consider: housing, utilities, food, transportation, insurance and personal debts.
Pay yourself first before adding to your emergency savings fund
This piece of advice is one you’ll hear a lot from financial planners — mainly because it’s a great tip and you deserve it! Your immediate expenses should always come first and then you should put money aside for your future goals. Make it a habit with each paycheck. Better still, arrange to have a percentage of your salary automatically transferred into a savings account by your employer so you’re not even tempted to use it elsewhere.
Get creative when saving for an emergency fund
In addition to regular contributions from your paycheck, start thinking of creative ways to save money. Can you cut back on your entertainment expenses? Do you have things you never use that you can sell? Are you shopping for deals and using coupons? Stretch your imagination and watch your emergency fund account grow.
Discuss your emergency savings fund with your banker
Talk to your banker to find out what type of savings account is best suited to your needs. You’ll want to learn about the APR they’re offering and the minimum emergency fund amount you can deposit. You’ll also want to know the best way to access your money when an emergency arises.
Where Should I Keep My Emergency Fund?
You have a lot of options when it comes to where to put emergency funds. From high-yield savings accounts to investing in a certificate of deposit, it can be beneficial to invest in short-term savings ideas that can help you rack up interest along the way:
Invest in a money market account
Similar to a high-yield savings account, money market accounts promise a certain percentage of return over your investment. But you’ll need to commit to a period of time. In most cases, you’ll need to sign on for at least a 6-month contract. But if you find yourself needing to dip into that savings to pay for a new dishwasher, some accounts allow you a limited number of monthly withdrawals.
Put your emergency fund money into a high-yield savings account
Available online where you can transfer funds directly from your checking or savings account, high-yield savings accounts can be a smart way to save. Many don’t require a minimum balance, have nominal fees and sometimes pay a higher annual percentage rate than your local brick-and-mortar bank.
Consider certificates of deposit
If your finances are rather stable and you’ve got a fair amount of liquid cash in your checking account, moving some of it into a certificate of deposit (CD) for a period of time can be a great way of building an emergency fund. Be aware that you won’t be allowed to access your money until it’s maturity date which can range from a few months to decades. But you’ll typically benefit with a better return on investment when compared to other emergency fund savings options.
Grow your emergency savings with a Roth IRA
Although you may have to pay a stiff penalty and potentially taxes for early withdrawal, Roth IRAs work well because they’re paid out on a pre-tax basis from your monthly payroll. Depositing into a Roth individual savings account this way decreases your annual taxable income.
And that can potentially save you thousands in money you’d otherwise need to hand over to Uncle Sam. So, it’s important to work with a financial advisor to be sure the idea’s a winning prospect.
Leverage several emergency fund savings options
Blending your savings strategy across several of the options identified here may work best for you. By leaving a few thousand dollars in an immediately available high-yield savings account, you’ll be able to access some cash when you need it.
But with the larger parcels of money earning more each year in a Roth IRA, you could accelerate your advance towards financial security. And with larger segments of your funds locked into two- or five-year CDs, you’ll have a diversified portfolio earning every cash for you step of the way.
The best news is that you’re protecting your goals by being proactive. Slowly building an emergency savings account is a solid investment in your future!
Prepare Your Finances for the Unexpected
When the unexpected occurs, you'll want to be prepared. There are many things to keep in mind when building an emergency fund, although saving money is a crucial first step for many. While you’re exploring your emergency fund strategies, be sure to check in with your American Family Insurance agent and review your coverage limits. You may be able to save more by paying your premium annually or by increasing your deductible.
Note: The information in this article is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other financial professional to determine what may be best for your individual needs.