Creating a budget is great but the reality is that life throws curveballs. That’s where an emergency fund comes into play. From unexpected medical bills to car repairs, emergencies can derail your budget and leave you scrambling. That’s unless you’ve already spent time building an emergency fund – a financial safety net that catches you when things get rough.
Why You Need to Start Building an Emergency Fund
Peace of mind: Knowing you have a buffer for unexpected expenses reduces stress and allows you to focus on resolving the issue at hand. Financial stress is no joke and making sure you’re ready when things go haywire can be a huge difference in your quality of life.
Avoids debt: Emergencies can lead to high-interest credit card debt or loans. An emergency fund helps you weather the storm without going into debt and that’s a huge thing because that $1,000 expense can quickly become $1,500 once you add in the long term and very high interest rate you’re paying on that credit card debt.
Financial security: A healthy emergency fund gives you options. You can face job loss or take time off without immediate financial pressure and can take your time making the choices that are right for you instead of scrambling and taking whatever comes along simply because you need the money.
Building Your Savings Castle, Brick by Brick
Building an emergency fund might seem daunting at first, but even small steps lead to big results. Here’s how to get started:
Start Small: Aim for $1,000 initially. This initial buffer can cover minor emergencies, motivating you to save more. That first step will be the key to building an emergency fund that can help you handle any financial problems that come your way.
Find Extra Cash: Review your spending. Can you cut back on subscriptions or eating out? I know it may seem hard to figure out how you can even save extra money with how much things cost today but setting up a tracking sheet can give you a good idea of where your money is going and find ways to cut back to help you set up that emergency fund.
Automate Savings: Set up automatic transfers from your checking account to your emergency fund. “Pay yourself first” ensures you prioritize saving. No matter what you do, it’s important that this automation goes into the right account for an emergency fund.
Choosing the Right Account
High Liquidity: Your emergency fund needs to be easily accessible. Savings accounts or money market accounts are ideal choices for this type of savings as they can easily be accessed, protect your money without risk of losses and can still grow even if it’s very slowly. Stocks are not the right spot for an emergency fund because they can drop quite a lot in a limited period of time which would be a problem if you need to access that money during that period of time. I’d suggest a standard bank account at a bank with a good reputation and one that offers a decent savings rate. Right now, I’m using a savings account with Capital One which offers a 4.35% interest rate. That rate can change as the fed changes interest rates but the principle is protected and insured by the FDIC as long as the dollar amount stays below $250,000.
Watch out for Limited Transactions: Some accounts might limit withdrawals per month. Choose an account with options that allow you to access your funds when needed.
From Starter Kit to Fortress: Growing Your Emergency Fund
Once you have $1,000, the next goal is to set your sights on 3 to 6 months’ worth of living expenses. The length can vary depending on your risk profile and how comfortable you’d feel going without income for the amount of time reflected. Longer emergency funds do exist but most of the time, the money beyond 6 months is better of being invested for the long term.
However, if you happen to work in an industry that is competitive and hiring may take longer than 6 months or if you have some medical issues that may require a longer break, you might want to aim for an emergency fund that’s even longer than six months.
Once you start saving, here’s how to keep the momentum going:
The 50/30/20 Rule: This popular budgeting strategy allocates 50% of income to needs, 30% to wants, and 20% to savings and debt repayment. Channel a significant portion of your 20% towards your emergency fund at first and once that’s ready then save in other areas. Often building an emergency fund should be the first step you take after setting up a budget and setting goals. It should go hand in hand with getting your employer 401k match as the most important saving steps to take when you start working.
Review and Reset: Regularly assess your budget. As your income increases or expenses decrease, adjust your savings contributions accordingly. For example, your emergency fund should cover 3 to 6 months of expenses so if your expenses go up, remember to revisit your emergency fund and save a bit more to cover those new higher expenses. One thing to note is that this can take some time to save especially if your income isn’t too high and it’s no small feat to actually build a sizable emergency fund in this high cost environment.
Celebrate Milestones! Reaching savings goals is a cause for celebration. Reward yourself for achieving milestones, but keep your financial goals in mind as it’s important to not let those celebrations get away.
Building an emergency fund is an investment in your financial future. With dedication and smart planning, you can turn that initial $1,000 into a robust safety net that empowers you to face life’s surprises with confidence.
Hopefully, you never have to tap into it but having that knowledge that the money is there for you in case you need it is great. If you do end up tapping into it, because of an emergency house repair or a job loss then make sure to get back to refilling it as soon as possible. Overall, building an emergency fund is no easy task but having it will make any financial issues you run into in your life so much easier to deal with!