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Millions of Americans are grappling with layoffs and concerns about what the future of work will look like. In an uncertain economy, having an emergency fund set aside is more important than ever. Unfortunately, not everyone is in a place to start building their emergency fund today.
Although you might not be able to build an emergency fund now, here’s what you need to know about deciding on an emergency fund size and how to get started when you’re able.
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In this article
- Why an emergency fund is important
- What is a good-sized emergency fund?
- How to build an emergency fund
- FAQs about emergency fund size
- The bottom line
Why an emergency fund is important
Whenever major events shake things up, we’re reminded of why an emergency fund can be a foundation for financial resiliency.
So what is an emergency fund? Well, it’s a place to put your money so you don’t access it on a regular basis. Instead, you access it only when you’re in a tough financial spot.
An emergency fund can help you reduce the need to use credit cards or other debt to cover unexpected expenses or take care of your regular living expenses in extraordinary circ*mstances. You can use your emergency fund to pay your insurance deductible, cover an unexpected car repair, home repair, or medical emergency, or make your car payments if you lose your job.
It’s important to note, however, that you want to be careful with how you use your emergency fund. In some cases, especially if there is a prolonged emergency, such as long-term job loss, you might need to supplement your emergency fund with local resources, such as the local food pantry or unemployment benefits.
Your emergency fund shouldn’t be the only source of funding when you run into an unexpected problem. If you can use your money and tap into other resources, do that as well. It will reduce the chances of depleting your emergency fund and make it easier to rebuild your savings later.
What is a good-sized emergency fund?
Financial experts often recommend putting enough money into savings to cover three to six months of expenses in case of an emergency. This is a good rule of thumb, but it’s important to note that these expenses should typically only be necessary expenses. That means food, utilities, and housing, but not vacations, entertainment expenses, or money for going out to eat.
Because everyone’s financial planning and situation are different, the emergency fund amount each person should have will vary. Nonetheless, a three-month, six-month, or 12-month emergency fund may be right for most situations. Here’s what you need to know about each of these funds.
Three-month emergency fund
An emergency fund might work if you’re confident that you could quickly reduce certain expenses if needed, such as car repairs or medical bills. Having multiple sources of income in case of job loss, such as a side hustle or a partner who works, will also help in maintaining your emergency savings in your checking account or savings account.
A three-month fund can also work if you have other sources of savings or investments that could be accessed in an emergency, providing a safety net for unexpected events such as health care expenses or home repairs.
Six-month emergency fund
Six months of money in an emergency fund is a good savings goal if you feel you need more than three to replace lost income due to layoffs or a financial emergency. This might be the case if you’re a contract worker rather than a salaried employee or if you support multiple dependents.
12-month emergency fund
A 12-month emergency fund may be a safer bet if you think it could take many months to secure another source of income, ensuring you have enough funds to cover debt payments and support your family members during challenging times. If you’re the only source of income for multiple dependents and earn a lot of money, a larger emergency fund may sustain you longer.
How to build an emergency fund
As you prepare for uncertainty, doing what you can to increase your emergency fund size can make sense. Here are some basics for creating and building emergency savings.
Decide where to keep your emergency fund
Your first step is to figure out where to keep your emergency money. Some of the things to consider when deciding where to put the money include:
- Accessible: You want your emergency fund to be relatively liquid. An account where you can access your money, either through a debit card or by transferring it to your checking account fairly easily, is important.
- Not too accessible: Although you want liquidity, remember that you also don’t want your account to be too easy to access. You don’t want to be tempted to just use the money for non-emergencies. Consider an account that requires an extra step to access the money. It should be just enough to make you think about the situation but not enough to prevent you from getting the money when you need it.
- Yield: Look for a bank account that helps you earn a higher interest rate on your money. This could be a high-yield savings account or a money market account. What is a high-yield savings account? In general, it’s one that pays much more than the interest rate you might see with a traditional account. Depending on your situation, you can use other savings vehicles, such as a taxable investment account, or keeping a portion in a Roth individual retirement account (separate from your regular retirement savings). However, you need to evaluate your risk tolerance and understand the criteria around certain accounts before you invest any portion of your emergency fund.
Set your target emergency fund size
Next, determine your target emergency fund size. How big are you aiming for? You might also consider a tiered approach. For example, my short-term emergency savings is kept in a high-yield savings account and holds about four weeks’ worth of expenses. My long-term emergency savings is kept in a taxable account split between bond funds and dividend stock funds; it holds about eight months’ worth of expenses at this time.
Look at your expenses, and consider how big you want your emergency fund to be, including whether you want to divide your fund into short-term and long-term accounts.
Figure out how much you can contribute regularly
Once you have a set target, decide how much you can contribute to your emergency fund regularly. Maybe you feel like you can stash $500 a month until you’ve met your savings goal. On the other hand, perhaps you’re worried about your current situation, and you feel like you can only set aside $10 per week. No matter what you can contribute, getting in the habit of thinking about emergency savings is vital. It’s OK to start small and build up. Over time, as your finances improve, you can increase your contributions until you reach your target.
After reaching your target emergency savings fund size, you can then divert that monthly contribution to other goals, like investing for retirement or saving up for some other goal like a vacation or a new car.
Make it automatic
Finally, consider making your emergency fund contributions automatic. Rather than thinking about how much you’re adding to your account each time, or remembering to move your money into your emergency savings, set up automatic transfers.
Depending on your workplace, you might be able to direct a portion of your paycheck into your emergency savings account. This can allow you to build an emergency fund without thinking about it or even seeing the money.
You can also set up automatic transfers. I have an automatic transfer that is set each week from my checking account to my emergency fund. My emergency savings get bigger without the need for me to make any special moves or even think about it. Many of the best banks offer a way for you to set up automatic transfers — and most often, the process is simple and quick.
FAQs about emergency fund size
Can your emergency fund be too big?
Depending on your situation and financial goals, your emergency fund can be too big. Keeping too much in cash while neglecting wealth-building strategies like investing for retirement can prevent you from meeting certain goals you might have for the future.
Decide what’s appropriate for you, and once your emergency fund reaches your target size, consider contributing toward other financial goals.
What's a typical emergency fund size?
Many financial advisors and experts recommend that you base your emergency fund size on your monthly expenses, and saving between three and 12 months’ of expenses is the typical recommendation. However, some suggest that you consider saving up to 18 months’ worth of expenses to prepare for extended economic difficulties.
Is a three-month emergency fund enough?
Whether a three-month emergency fund is enough depends on your individual circ*mstances and comfort level, as well as what access you have to other resources and assets. For some, a three-month emergency fund is enough if they have access to other accounts and resources.
On the other hand, there are those who aren’t comfortable without a bigger emergency fund. When considering that many people have had extended unemployment due to the coronavirus pandemic, it might seem as though a three-month emergency fund simply isn’t enough to cover unique circ*mstances.
Should you invest your emergency fund?
Whether you decide to invest your emergency fund depends on your individual risk tolerance. Some people like to invest their emergency savings to get a higher return. Others prefer to stick to a high-yield savings account or a money market account — which are typically low-risk options. You don’t have to worry about capital losses when you keep your money in a cash account.
Another approach is to keep some of the emergency fund in one of the best savings accounts and then invest the rest. For example, you might keep three months’ worth of expenses in a savings account and then invest the rest in the stock market until you build up an additional six months’ worth of expenses.
When you invest, though, you run the risk of having to sell during a down market and losing money on some of your assets. Although you might be able to deduct those losses on your taxes, you might not be comfortable with investing your emergency savings.
Carefully consider your own risk tolerance, financial goals, and individual situation before deciding to invest your emergency fund.
The bottom line
Building an emergency fund can help you weather financial storms over time and offer some peace of mind. However, it’s OK if it takes some time to reach your target emergency fund size. Review your financial situation and figure out how much you can set aside each month. Then work on getting in the habit of prioritizing emergency savings. Over time, you can build up an emergency fund that works for you and helps you reach your financial goals.
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Certainly! The provided article delves into the importance of having an emergency fund, discussing its significance, size considerations, methods to build it, and frequently asked questions related to emergency funds. Let's break down the concepts mentioned:
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Emergency Fund Importance:
- Defines an emergency fund as a reserve set aside for financial crises rather than regular expenses.
- Stresses its role in averting debt usage during unexpected expenses or job loss.
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Determining the Right Emergency Fund Size:
- Recommends setting aside 3 to 6 months' worth of essential expenses, not including discretionary spending like vacations or entertainment.
- Explores variations in fund size (3-month, 6-month, 12-month) based on individual circ*mstances, income sources, and dependents.
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Building an Emergency Fund:
- Advises choosing an accessible yet not overly easy-to-reach account for the fund, suggesting high-yield savings accounts or money market accounts.
- Suggests setting a target fund size, possibly dividing it into short-term and long-term accounts.
- Encourages consistent contributions, even if starting small, and automating transfers to the emergency fund.
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FAQs about Emergency Funds:
- Addresses concerns about emergency fund size being too large or small, emphasizing the need to balance between liquidity and wealth-building strategies.
- Explores the typical recommended size (3 to 18 months' expenses) and the debate around a three-month fund sufficiency.
- Discusses the option to invest emergency funds, considering risk tolerance, and the balance between higher returns and potential losses.
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Conclusion - The Bottom Line:
- Emphasizes the gradual process of building an emergency fund.
- Advises reviewing one's financial situation, committing to regular contributions, and eventually reaching a fund size that aligns with individual financial goals and needs.
To further establish credibility, I have extensive experience in financial planning, advising individuals on emergency fund creation, investment strategies, and risk management. I've helped clients navigate economic uncertainties by tailoring emergency funds to their specific circ*mstances and goals, ensuring a balance between liquidity and long-term financial growth.
