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Emergency fund: What it is and how to build one
Five steps to build an emergency savings account and ward off unnecessary financial stress.
Nearly 40% of Americans wouldn’t be able to cover a $400 emergency without going into debt. An emergency fund helps by giving a safety net to fall on when the unexpected happens.
What is an emergency fund?
An emergency fund is a financial safety net you can rely on if a major unexpected event happens in your life. Unlike rainy day funds that aren’t meant for smaller, one-off expenses, an emergency fund is there to help in significant times of crisis. People commonly use emergency funds for:
- Job loss
- Major illness or injury
- Major home repairs caused by natural disasters, water leaks, mold, etc.
5 steps to build an emergency fund
Follow these steps when building your emergency fund.
- Create a budget. You won’t know how much you’ll need to save each month for your emergency fund until you know how much you spend each month. That starts with creating a budget.
- Decide how much to save. If you’re just starting your emergency fund, set a smaller goal of $500 or $1,000. Once you get there, you can set a higher goal of three to six months’ of expenses, depending on your needs.
- Decide where you’ll keep your money. There are six types of accounts you can use for your emergency fund. Start out with a high-yield savings account from a digital or online bank first, then decide if you’d like to move some of your savings into a CD or Roth IRA once you’ve saved a nice buffer. Just note that you won’t want to move all your funds into a CD or Roth IRA, as you may pay a penalty when you try to access your money for emergencies. Keep all or most of your emergency fund in an accessible place.
- Automate your savings. Set your bank accounts up so that part of your paycheck goes to your emergency fund each time you get paid. If money is tight, start with a small amount like 5%, then work your way up. Every little bit counts and no amount is too small to start saving.
- Sock away unexpected money. Boost your emergency fund by saving any extra money you receive throughout the year, such as birthday or holiday money, work bonuses, tax refunds, credit or debit card rewards and so on.
How much should I keep in my emergency fund?
Most experts recommend keeping three to six months of basic expenses in your emergency fund. But this is a general rule of thumb. The most important thing is to save what you can — whether that’s $50 or $500 a month.
Pros and cons of an emergency fund
Having an emergency fund comes with a host of benefits, but there are also a few caveats to keep in mind.
Pros
- Gives you a safety net. An emergency fund reduces your chances of having to take on more debt when an unexpected expense pops up.
- Reduces stress. Have peace of mind knowing you have money waiting if you lose your job, develop a serious illness or need to make major home or auto repairs.
- Helps your credit score. An emergency fund doesn’t directly improve your credit. But it does help you avoid maxing out on credit cards and worrying about missing payments if hard times hit — two factors that can lower your score.
Cons
- Takes time to build. It could take months or years to build up your emergency fund. You can speed up the process by saving unexpected money and using a budget to reduce expenses. If you need money now, consider an emergency loan as a last resort.
- Potential withdrawal limits. You can typically only make six withdrawals a month from a savings account. There may also be limits on how much money you can withdraw at one time. For example, Bank of America only lets you transfer out $1,000 a day.
- Doesn’t work for all account types. Avoid keeping your emergency fund in a CD where you’ll get penalized for accessing it early. Instead, opt for a high-yield savings account from a digital or online bank where you’ll have easier access to it.
When should I use my emergency savings?
Emergency funds should be used for major emergencies and not for expenses you forgot to plan for, like birthday gifts, car tag renewals, property taxes, etc.
If you can answer “yes” to these two questions, it’s most likely an emergency.
- Is this an urgent expense?
- Is it unexpected?
Compare accounts for your emergency fund
Compare popular savings accounts by APY, minimum deposit and fees to find the right one for your emergency savings fund.
Bottom line
Emergency funds can help you add a buffer between you and the unknown. How much you should save depends on your financial situation and goals. As always, compare savings accounts to find one that’s best for your emergency savings.
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