June 06, 2023
What is an emergency fund?
Tips to prepare for the financially unexpected
You may have heard the term, “saving for a rainy day.” It’s an informal phrase used to describe putting money away for an unexpected expense. Unfortunately, not all rainy days are created equal. Sometimes, it’s downright pouring outside.
In the same way, not all unforeseen events are created equal. Some are more severe than others and become very real emergencies. To stay ready for unexpected circumstances, there are a few important steps you can take to develop and maintain an emergency fund.
Understanding the emergency fund
Let’s start with a formal answer to the question: “What is an emergency fund?” According to the Consumer Financial Protection Bureau:
“An emergency fund is a cash reserve that’s specifically set aside for unplanned expenses or financial emergencies. Some common examples include car repairs, home repairs, medical bills or a loss of income.”
These are great examples of unpredictable life events. However, they shouldn’t limit how you view and value your emergency fund. Only you can determine what situations might be critical to you.
Knowing your own circumstances is especially important in figuring out how much you should put away. Some experts suggest one to two months of wages, while others say enough to cover three to six months of household expenses. It depends on your lifestyle and risk tolerance, but here are some foundational ideas of a sensible amount to put aside.
Start with your salary, specifically how much you get paid and how often. This will help determine how often you add to your emergency fund.
Next, consider your monthly expenses. This could include rent, car payments, personal loans and utility bills. These should take priority over your emergency fund. But don’t overlook the cost of food, clothing and entertainment in your calculation.
Once you’ve subtracted your monthly expenses from your monthly income, you should have a positive amount left over. Set aside a portion of this money that you can comfortably maintain each month. Then it’s time to decide how to finance your emergency fund.
How should I maintain my fund?
There are a few ways to make sure your emergency account stays funded and ready should you need it.
1. Open a high-yield savings account: These pay several times above the national average of a standard savings account. Before you decide, consider the terms, such as the initial required deposit amount, minimum balance requirements and ability to withdraw at any time. You want to ensure your emergency fund doesn’t cost you and that you have access to it when needed.
2. Add to your fund at regular intervals: Once you decide how much you’d like to put away, add to your fund regularly. This could mean once a paycheck or once a month. Automatic deposits can help you stay on track.
3. Monitor your progress: Regularly check in on your savings and overall personal finances. You may need to adjust your savings and spending periodically.
Don’t be afraid to use your emergency fund.
Sometimes it can be hard to determine when you should withdraw money from your emergency fund. In other words, “What’s an emergency?” But you can feel comfortable using the fund when the unexpected arises, particularly if you’ve taken time to consider the circumstances your fund should cover.
That’s what it's for, and you worked hard to get prepared. If you maintain good financial health, you should be able to withdraw from your account and continue to build the fund back up again.
