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Sometimes unexpected — and unpleasant — financial hiccups happen: Your car breaks down, your electric bill soars, an unexpected medical bill pops up, or you experience job loss. An emergency savings fund can help you pay your bills and relieve stress during difficult times.
A savings account for financial emergencies allows you to pay your rent or mortgage, put gas in your car, or replace a failed appliance without going into debt if you unexpectedly lose income. Even an emergency fund as small as $250 can lessen the chance of eviction or inability to pay an important bill for American families, a study by the Urban Institute found.
What is an emergency savings fund?
An emergency savings fund is money in an account that is meant solely for emergencies such as:
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A car repair
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Paying for your housing, insurance, food, and other essential expenses if you lose your job or your income drops
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An unexpected medical issue
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A home repair, such as a leaky roof or a plumbing problem
An emergency fund is not the same as your savings or retirement accounts. The point of an emergency fund is to help you avoid dipping into your savings or taking on high-interest debt by using a credit card or loan to pay for these expenses.
How much should you keep in an emergency fund?
A good rule of thumb is to keep enough money in your emergency savings fund to cover three to six months’ worth of living expenses. For example, if your monthly expenses are $3,000, aim to keep at least $9,000 in your emergency fund. That way, you could still pay for essentials for several months if you lost your job. On the other hand, if you have a job with fluctuating income, you might want to target an amount covering expenses for six to nine months.
To figure out how much money you should save in your emergency fund, make a list of your must-pay expenses for each month in categories such as:
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Housing
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Utilities
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Food
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School tuition
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Cell phone and internet
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Transportation
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Insurance
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Childcare
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Debt payments
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Taxes
Once you know how much you spend each month, you’ll know what size emergency fund you need.
Where should I keep my emergency fund?
Keeping your emergency fund money separate from your regular checking and savings accounts is a good idea. The account should earn interest and be easily accessible, meaning you can quickly get your hands on the money. It’s also smart to look for Member FDIC or NCUA accounts. The Federal Deposit Insurance Corporation (FDIC) and National Credit Union Administration (NCUA) are federal agencies that oversee banks and credit unions. These agencies also insure the money people deposit in certain bank and credit union accounts. FDIC-insured and NCUA-insured accounts cover funds up to $250,000 per person, per institution, per ownership ownership category. Here are a few types of accounts to consider:
Traditional savings accounts: Many accounts at conventional brick-and-mortar banks don’t earn much interest, but they can be very convenient. You can easily withdraw the money via an ATM or by visiting a bank branch.
High-yield savings accounts: These accounts are very similar to traditional ones but often earn 10 times or more in interest. The downside is that because most of these accounts are offered by online banks, you won’t be able to visit a bank branch to take out money. You might need to set up a transfer from another account to deposit or withdraw money, which can take one to five days to process. However, many of these accounts offer ATM withdrawals and mobile app deposits.
Money market accounts: These accounts are a sort of cross between savings and checking accounts and often come with a debit card or checks. The highest-yield money market accounts also offer rates similar to high-yield savings accounts. The potential downsides of a money market account are that you may have to put down a large deposit to open the account and maintain a minimum balance to avoid account fees.
How to build an emergency fund
To start your emergency savings fund, take some time to figure out what you can contribute to an account each week or pay period. Don’t worry if it looks like it will take you a long time to reach your goal of saving enough to cover three to six months of expenses. Even small contributions, if you keep at them regularly, will put you on track to build your fund.
One good option is to set up an automatic, recurring transfer from a separate checking or savings account. Another is to direct deposit a portion of your paycheck into your emergency fund. This makes saving automatic and can reduce the temptation to spend your money elsewhere, sacrificing a regular contribution.
And just as an emergency fund is ideal for paying unexpected expenses, it’s also a great place to deposit unexpected income. If you receive a higher-than-anticipated bonus at work or a tax refund, put some or all of that money into your emergency fund to help it grow.