An emergency fund helps protect your financial well-being as unexpected life events can happen ranging from bills to job loss. With life’s unexpected twists and turns, personal income can become subject to change so it’s always a good idea to be ready for anything that can come your way.
What is an emergency fund?
An emergency fund is money saved for unexpected events due to life’s challenges or changes. These events might include unemployment, a medical emergency, home repairs and/or unexpected transportation (flights, broken car, etc.).
How can you build up your emergency savings?
Starting your emergency fund can be hard because most people can’t put away several months’ worth of funds immediately. Ideally, your emergency fund should be 3-6 months of expenses. While that may sound like a lot, keep in mind that number should cover your bare-bones expenses. If that sounds like a lot, don’t get discouraged because the most important part is actually starting. Start saving by starting with $500 to $1,000 that will protect from many minor emergencies. To help build your emergency fund, create and live on a budget that prioritizes saving money. By creating a budget and tracking your expenses you can determine what you’re spending on, set spending limits and allocate where your money goes, including but not limited to your emergency fund. Think of the fund as a bill you have to pay. You could create automatic contributions to your emergency savings each payday so that money moves to savings before you have a chance to spend it.
Where should you keep your emergency fund?
Keep your fund in an account where you can access the money easily in case of an emergency. Keep it in an account that is safe from loss while gaining interest. You don’t want to invest your emergency fund in risky assets to try to earn higher returns. This money isn’t an investment — it’s a safety net.
Savings vs. emergency fund, what’s the difference?
While these two accounts overlap in their uses, their purposes are what distinguish one account from another. The reason behind your emergency fund is that it is separate from other accounts that are only accessible upon emergency. You can think of your emergency fund as a life jacket—you might not always need one but when you do, it saves you from frantically treading water.
Your traditional savings account holds money for many purposes a house, a car, clothes, or a rainy-day fund. While you can store your emergency money in the same account as your savings account, it may be beneficial to separate your funds if you’re going to be tempted to dip into your emergency fund for extra cash for the moment.
To have a life jacket, you need to invest in one. For the same reason, it’s important to safeguard your emergency money—even if that means protecting that money from yourself, too.
Where can you keep your emergency money?
Given that this fund could sum several months of income, you’ll have a large chunk of change that could grow depending on where you decide to house this money.
Places to store your emergency money include:
Roth IRA – is a tax-advantaged retirement savings account that allows you to withdraw your savings tax-free. Roth IRAs are funded with after-tax dollars; the contributions are not tax-deductible. But once you start withdrawing funds, the money is tax-free.
High Yield Savings — A high yields savings account might be a good idea if you’re at the beginning of your savings journey as many accounts are offered without any minimum balance requirements. Usually these are bank accounts that earn you a higher interest rate for deposits than a traditional savings account. You might also see them referred to as high-interest rate savings accounts
Certificate of deposit (CD) — A certificate of deposit is a product offered by banks and credit unions that offers an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit untouched for a predetermined period of time.
Traditional Savings Account — A traditional savings account offers the most secure location to store your money as they tend to be FDIC insured (depending on the account and banking institution). This might be a good option if you’re still researching which of the above choices could be the best fit for you or if you’re looking for a simpler option.
You work hard for your money and your money should do the same. Consider investing in your future by saving a portion of your income to pad your lifestyle for harder times. With an emergency stash stored away, you can take risks or continue living the way you do now knowing you have a safety net. An emergency fund gives you these options.