You know you need to have some money set aside for life’s emergencies, but how much is the right amount? Should you have a separate fund for your car, for unemployment, and for medical problems? At the end of the day having some sort of emergency fund, specific or not, is better than having none at all. Here are some helpful information to help you get started with building an emergency fund.
How Much Money for Your Emergency Fund
A general rule is to have a minimum of 3 to 6 months of your monthly expenses saved up for emergencies. This helps you in several ways: if you lose your job, you could keep your lifestyle and spending the same for 3 to 6 months while job hunting. In reality you would probably drastically cut back to extend how far that money could carry you.
And for most people, having 3-6 months of their total monthly expenses saved up will help cover most essential costs like housing, food, transportation, etc.
Calculate Your Emergency Fund
To calculate your emergency fund amount, do the following:
- Gather all your statements, bills and expenses for the last 3 months.
- Add up all your expenses. If you’re already budgeting, you should have this number handy.
- The total is your 3-month Emergency Fund amount.
- Multiply by 2 for a 6-month Emergency Fund, 3 for a 9-month, and 4 for a 12-month.
For further discussion, see How Big Should an Emergency Fund Be?
Where Should I Store My Emergency Fund?
The answer is somewhere that is safe, accessible, and hopefully pays you a bit of interest so that you money can keep working for you.
Best Place to Keep Your Emergency Fund
Sure, you can save it at your local bank or at home, but it won’t earn hardly any interest. A better option is in an online savings account that pays closer to 2% interest and still meet the safe and accessible requirement. Of course, the point of the savings isn’t to earn interest…that’s just an extra perk. The point is to have cash on hand when times get tough and unexpected costs arise.
Should You Invest Your Emergency Fund?
Also, it is generally not a good idea to keep your emergency fund invested in the stock market due to the much higher risk of short-term loss and higher correlation to a potential job loss. For example, a lot of people lost their job during the last recession and the Stock Market also tanked. If you kept your emergency fund in the Stock Market, you’d have been in a bad position.
For a more in depth discussion and more ideas about where to keep your money, read: Where to Keep Your Emergency Fund.
How Do I Start an Emergency Fund?
If you’re already saving money, it is an easy task of opening up a new account (or a sub-account) and put your Emergency Fund in the new account. You want it to be separate from your day-to-day accounts so that you only touch it in emergencies.
Start with $1,000
If you saved $20 per month on your insurance and cut $80 from your monthly expenses, you now have $100 each month that you can set aside for the future. That’s $1,200 per year. It might take you a while to reach your target goal, but having any kind of money saved up in the mean time is a good thing.
Also, consider selling a bunch of things to build up a quick cash reserve.
Work Toward Full-Funded Emergency Fund
Don’t stop when you reach $1,000. Keep saving until you reach your goal of 3 to 6 months of your monthly expenses saved up for emergencies.
Tapping Your Emergency Fund
Eventually, you will have to dip into your emergency fund. When this happens, it is important that you do so in a manner that is planned.
First, make sure that you really are in an emergency situation. Wanting a new TV or getting a down payment for a car, do not qualify as “emergencies.” Set up separate savings accounts for these short term goals. If you can pay for something without tapping into your emergency savings, do so.
As you use your emergency money, look for ways to stretch your income further. Get a temporary or a part-time job while you look to replace your full-time job, or have your partner work, so that your emergency fund isn’t your only source of income. Look at your spending and see where you can cut back so that your emergency fund lasts longer.
Finally, remember to replace money you take from your emergency fund. You will have to build your fund back up after depleting it a little bit. However, you will be glad you did: You want that money available for the next emergency.
Build on a Solid Foundation
Your emergency fund is the foundation that your finances are built on. It helps stabilize your financial situation and gives you an easy “out” when you run into a money crisis.
Of course you will only truly see the value of an emergency fund the first time you use it. Realizing you didn’t have to take on additional debt and paid cash for whatever problem popped up is an amazing feeling.
Your To Do List
To shore up your finances, take these steps to build an emergency fund:
- Set a goal based on your personal situation.
- Automatically set aside money into an account you won’t touch unless it is a true emergency.
- Consider selling stuff you own to quickly ramp up your emergency savings.
Do you agree? I’d love to hear from you. Leave a comment with your thoughts.
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.