If you’ve read any financial planning literature, you know you need an emergency fund– money set aside to help you cover unexpected expenses. If you have an emergency fund, little disasters, like a broken dishwasher, are a lot more manageable. Rather than blowing your budget or relying on credit cards, your emergency fund will help solve the problem while keeping you financially on track. In addition, an emergency fund could help you through a period of unemployment should you lose your job. It could provide a way to pay bills while you search for another job or make the necessary adjustments to cover the loss of income.
Before we get into the details of creating an emergency fund, let’s take a closer look at the definition of a financial emergency. Some think an emergency is the same as an unexpected expense, such as a large car repair bill or having to pay back-taxes. While these are unfortunate events, they can be anticipated and planned for. A true emergency should be defined as an expense that could not have been anticipated. Getting your annual bill for car insurance in the mail may feel like an emergency, but actually it is a failure to anticipate your expenses accurately.
How can an emergency fund help with your financial plan?
You never know what life holds in store. Every day, we face the potential of all kinds of life-changing events we can never anticipate – from a broken ankle to a car accident to a lost job. For Americans living paycheck to paycheck, an unexpected event spells financial trouble. Paying for an emergency on a credit card is like putting out a fire with gasoline. It’s not a good use of your hard-earned dollars and the increased payment threshold makes it that much harder to stay afloat financially. Emergencies are inevitable, so plan ahead!
How much should you save?
There are many schools of thought on how much cash you should keep accessible for emergencies. Most experts universally agree that you need at least $1,000 cash put away in a savings account that you don’t touch, not even to pay bills. Some recommend that you create an emergency fund with savings equal to four to eight months of income. Still others say that your emergency fund should be enough to cover essential expenses such as housing, transportation and food for three to six months.
Keep your finances on track with a sustainable, automated plan
To save up the money you need, consider creating a budget and a savings plan you can sustain. Put away a small amount each month, but not so much that it creates a financial crisis! If possible, automate the savings transfer so it takes place without any thought. Keep emergency funds in a separate account so it’s harder to whisk the money away for expenditures that are not true emergencies.
Help protect your retirement savings
An emergency fund is also a good way to protect your retirement savings. According to a recent survey, 14% of Americans say they would likely tap into their workplace retirement account to cover an emergency expense.1
Financial professionals typically recommend accumulating an emergency fund of at least six months' worth of living expenses. However, having just a $500 fund is a great start, providing you with some readily available cash to see you through many unexpected expenses so you can protect your retirement savings.
The more you know about your spending, the better you can plan for spikes in your expenses and the fewer true emergencies you will have to weather. Create another non-emergency account to save money for predictable, occasional expenses such as insurance, taxes and home and vehicle maintenance.
The most important thing you need to know about emergency funds is that you need one. All experts agree that the best protection against disaster is a prudent reserve. Be protective of your life and family by establishing your personalized emergency fund today.
1. T. Rowe Price. "How Untimely 401(k) Loans Can Impact Your Retirement Savings Over Time," July 24, 2023.
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