Do you have an emergency fund? If not, saving for an emergency should be your first financial priority. Your emergency fund can help you stop adding to your debt whenever you have a financial hardship or help cover the things you don’t budget for. In this article, I’m going to show you how to build an emergency fund.
What Is An Emergency Fund
An emergency fund is money set aside to cover large unexpected expenses or to help you through hard financial times—like a job loss. Having an emergency fund also prevents your budget from getting thrown off.
Preparing for the unexpected is necessary if you want to be financially free.
Do You Have A Budget?
Before you start to build your emergency fund, you need to have a budget first. Having a budget allows you to see how much your expenses are. You need to know how much your monthly expenses are in order for you to know how much money you need in your emergency fund.
If you’re just starting out, you can download this FREE Monthly Budget Worksheet.
However, if you want to get serious with your savings and need something a little more sophisticated, you can get my Budget Templates.
These templates make it easy to see exactly what percent of your income you’re saving. It also shows you what percent of your money you are spending. This is the template I actually used to save over 50% of my income and it is the same template I use to this date.
How To Build An Emergency Fund
Choose The Size Of Your Emergency Fund
The size of your emergency fund depends on your personal situation. I suggest you have an emergency fund that is at least three to six months’ worth of living expenses.
Once you have your budget set up, you should have a good understanding of how much your living expenses are.
When I say “living expenses” I mean only necessities, such as rent and groceries. I don’t mean shopping, entertainment, dining out, or vacations.
If you are ever in a situation where you have to rely on your emergency fund, you shouldn’t be taking vacations or dining out anyway.
I recommend saving three months’ worth of living expenses if you have relatively strong job security. I recommend six months (or more) if you have some instability in your employment or if finding another job could take you a long time.
Once you have an idea of how much money you need in your emergency fund, set a monthly savings goal. Then I want you to automate your savings by setting reoccurring transfers to your bank.
Where To Keep Your Emergency Fund
Since an emergency can strike at any time, having quick access to your money is crucial. Another important factor is your money needs to be safe. You don’t want to put your money in a place that you can lose money.
I recommend keeping your emergency fund in a secure location, such as a money market account or a savings account. Let’s discuss the difference between a savings account and a money market account.
A savings account is a basic bank account. When you deposit your money in a savings account, a bank makes loans with your money. The bank pays you interest for the privilege of using your money.
Open a high yield savings account to an online bank account. You get two benefits by opening an online savings account:
- They usually pay higher interest on your money than a brick and mortar bank; and
- It reduces impulse purchases because your money is a little harder to access. With online banks, it usually takes a few business days for the money to be transferred to a physical bank where you can withdraw cash.
I recommend Radius Bank because it offers competitive interest rates, has no monthly maintenance fees, and no minimum balance requirement after $100 to open. Also, their checking account has free ATMs worldwide.
Minimum account balances are typically low; however, a savings account usually yields a lower interest rate than a money market account.
Money Market Account
A money market account is a type of savings account that usually earns a higher amount of interest than a basic savings account. However, it usually requires a higher minimum deposit and daily balances.
Some additional benefits you get with a money market account that you do not get with a savings account are that you will typically receive a debit card and checks. This makes your account easier to access in case of an emergency and is more liquid than a savings account.
Download this FREE Savings Tracker to keep track of your emergency fund savings goal. Color in each box as you put money towards your savings goals. Use this visual to make savings fun and motivate you to keep going until you reach your goal!
Savings accounts and money market accounts are similar in the sense that the Federal Deposit Insurance Corporation (FDIC) insures deposits. The FDIC insures against loss up to the federal limits of $250,000.
You can deposit money into savings and money market accounts as often as you want. However federal regulations prohibit withdrawals to no more than six per month.
Please don’t confuse money market accounts with money market funds because they are very different. Money market funds are a type of mutual fund that invests in the debt of governments and corporations.
In short, the difference between a money market account and a money market fund is money market funds are seen as an investment and are not FDIC insured. So if a bank fails, you will not get your money back from the FDIC with a money market fund.
I personally like money market accounts better than savings accounts for my emergency fund because they usually pay higher interest rates than savings accounts.
But keep in mind you will probably need a higher minimum account balance than a savings account—although there are some banks that do not require a higher minimum balance for their money market accounts.
Taking all these things into consideration, you should choose the option that’s best for you. You can start your research by seeing some of the best savings accounts HERE and some of the best money market accounts HERE.
Where NOT To Keep Your Emergency Fund
Now that you know how to build an emergency fund, it is important to know what accounts you should NOT hold your emergency fund.
At some banks, other types of savings accounts include certificates of deposit (commonly called CDs).
With CDs, you deposit your cash with a bank and agree not to withdraw your money for a specified period of time. In return for that promise, the bank will usually pay you a higher interest rate than a savings account and a money market account.
I typically don’t recommend keeping your emergency fund in a CD, although it pays a higher interest rate than the two other savings accounts we discussed. The reason is your money is locked in for a specified period of time.
If an emergency arises and you are forced to withdraw your money from a CD prematurely, you will get hit with an early withdrawal penalty.
CDs are a good choice for short term savings goals that you know you won’t need the money for at least a year or two in the future. CDs are not for emergency funds because you won’t know when you will need the money.
Stocks or Bonds
You also don’t want to keep your emergency fund in stocks or bonds.
You may be tempted to put your emergency fund in stocks or bonds because you want to earn more interest than a savings account. However, this is a mistake because the value of your stocks or bonds can go down.
Although you can sell stocks or bonds if you need to, you may have to sell it at a loss if your emergency occurs during a downswing.
For emergencies, you need a guarantee that your money will be there when you need it. Therefore, play it safe and keep your money in a savings account or money market account.
Congratulations on learning how to build an emergency fund. You want to make sure you have a budget before establishing your emergency fund. Having a budget will help you determine how much you need in your emergency fund.
Once you have a good idea of your monthly necessary expenses, I recommend building an emergency fund that will cover at least 3-6 months of expenses.
Finally, be sure to keep your emergency fund money in a safe place. I recommend somewhere like a savings account or money market account. Knowing how to build an emergency fund will allow you to feel more secure because you will be prepared for the unexpected.
- How I Use My Monthly and Yearly Household Budget Spreadsheet
- Cutting Your Monthly Expenses: Why It Is Absolutely Necessary
- How I Saved $300,000 In 4 Years
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