Let’s say your car broke down tomorrow… how would you pay for it to get fixed?
If you’re like a lot of people, you’d stress about where to get the money – or have to pull out a credit card to cover it.
Having an emergency fund is meant to save you from situations like this!
Today, we’re going to talk about what an emergency fund is, how much should be saved in an emergency fund, and how to get started building your emergency fund.
Although I am a CPA by profession, I am not YOUR CPA. All content and information in this post is for informational and educational purposes only, does not constitute accounting, tax, or financial advice and does not establish any kind of CPA or accountant-client relationship.
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What Is An Emergency Fund?
An emergency fund is basically a savings account that you only use for emergencies. It’s meant to cover life’s unexpected events that you wouldn’t normally budget for – like if your car breaks down, you fall and break your arm, your dog needs emergency surgery, etc.
You decide what amount you want for your emergency fund, get that money saved, and then you don’t touch it for anything except an emergency.
Why is it Important to Have An Emergency Fund?
An emergency fund is basically there to give you peace of mind when something unexpected does happen.
Instead of immediately stressing out that you are going to have to come up with a chunk of money to cover a situation, you can focus on what’s happening without also having to worry about your finances.
It also keeps you from going into debt when something unexpected happens. You will have cash on hand to cover it instead of using a credit card.
A lot of people want to have a credit card “for emergencies,” but that just means you’ll end up having to make payments for the emergency over time… plus interest.
Emergency Fund vs. Savings
An emergency fund should be separate from any other savings you have.
For example, if you are saving up for a new couch, you want to keep that money separate from your emergency fund.
Having one saving account for everything you are saving for makes it way too easy to spend some of your emergency funds on things that are not true emergencies.
If you save up $2,000 for a vacation and it’s sitting in the same account as your $3,000 emergency fund, it’s way easier to convince yourself that you could use a little bit of the emergency fund money on your vacation because the money is mixed together.
It also gives me a lot of peace of mind to see my untouched emergency fund balance sitting there for whenever I need it.
When Should You Use Your Emergency Fund?
Your emergency fund should only be used when something urgent and unexpected happens.
Wanting a new mattress, getting invited on a last-minute weekend getaway, or finding an amazing sale on that bag you’ve wanted are not emergencies!
Emergencies are things like your water heater going out and flooding your basement, your dryer trying to catch on fire, your car breaking down, or your pet needing emergency surgery (all things that have happened to me!).
Where To Keep Your Emergency Fund
As I mentioned before, you want to keep your emergency fund in its own savings account.
It should be really easy to access in case of an emergency, but separate enough that you aren’t going to be constantly tempted to spend it.
I personally use a high-interest savings account in order to make a little bit of interest on the money I have in there.
My savings accounts (sinking funds and emergency fund) are set up in a separate bank from my normal spending accounts. They are all connected to a separate checking which I have a debit card for.
If I need money from my emergency fund, I can just quickly transfer the money from the savings to that checking account using my online banking.
The separate debit card helps me consider that card as my “sinking fund/emergency fund” card only. This keeps me from being tempted to use that money for anything other than what it’s meant to be used for.
Why You Shouldn’t Keep Your Emergency Fund Money in Your Checking Account
Again, the main reason you don’t want to keep your emergency fund in your checking account is so that you don’t spend it on things that are not emergencies.
If there is a big chunk of money in my checking account that I’m used to spending money out of, it’s going to be way easier to justify spending it than if it’s physically set aside for its own purpose.
Plus, I just think it’s way easier to keep track of my money when I sort it into separate accounts.
How Much Should Be Saved In An Emergency Fund?
Now that you know why an emergency fund is important and how you should hold onto it, let’s go over how to know how much money should be saved in your emergency fund.
1. Review Your Monthly Spending
The general recommendation that you’ll hear about emergency funds is to save three to six months’ worth of expenses. This would cover you for a while if you lost your job or had an extended leave from work.
To figure out a month of expenses, you’ll need to look at what you spend on a monthly basis on essential things. So rent, utilities, groceries, etc.
Don’t include things like cable, eating out, or getting your nails done, because these are things you would need to stop doing to save money if you lost your job.
If you want to have three months of expenses saved, you’d multiply your monthly living expenses by three. This would be the amount you want to have saved in your emergency fund.
It might seem totally overwhelming to try and save six months’ worth of expenses at once, especially if you aren’t used to saving money. The next few points will help with that!
2. Decide What is Realistic For You
Make sure you are setting a goal that is realistic for your current lifestyle and situation.
If you’ve never saved more than $500 in your life, don’t set a goal to immediately save $20,000 in your emergency fund.
That can be an eventual goal, but start smaller to begin with.
You also don’t want to set a goal that requires you to save $500 a month for your emergency fund if you don’t have that much extra cash flow in your budget (we’ll talk about budgeting a bit later in this post.)
If all you can manage is saving up $50 per paycheck to start with then just do that.
Saving something in your emergency fund is always going to be better than nothing, so make sure you are considering what is actually doable for you as you decide what amount you want to save.
3. Start With a Smaller Amount
If you’ve never had an emergency fund before or you’ve never really had any money saved, I definitely recommend starting with a smaller savings goal.
Set a goal of $1,000 or $1,500 to get started.
You’ll still be able to take care of most emergencies with this amount and it will keep you from having to pull out your credit card for a lot of unexpected things.
Getting this first amount saved will often be the hardest part of the entire process because you have to change your habits in order to start saving money.
This is part of the reason why setting a small goal to start is a better idea – it gives you a realistic savings goal to hit as your first experience setting money aside.
4. Evaluate Your Other Financial Goals
While having an emergency fund is important, you should weigh the benefits of saving all your extra money against your other financial goals.
For example, if you are really wanting to pay off your debt, you may want to focus more of your budget on extra debt payments rather than saving it.
If you have other goals you are working toward, I recommend saving between $1,000 and $2,000 in your emergency fund to start. Then, focus on working on your other financial goals.
You can then come back and add more money to your emergency fund once you have taken care of debt or your priorities change.
Check out this post about whether you should save money while paying off debt to help you decide which is more of a priority for you.
How to Start Building Your Emergency Fund
Once you’ve figured out how much money you want to save in your emergency fund, it’s time to get started!
It can be overwhelming to think about saving a larger amount of money – especially if you are not used to saving.
Let’s go step by step over how to start building your emergency fund in a way that makes sense for your budget.
1. Set a Savings Goal
Your first step is to set a savings goal. We’ve already talked about how to decide how much to save in your emergency fund.
As I mentioned before, if you are saving money for the first time, I would start with an amount between $`1,000 and $2,000.
Once you’re confident in your budget and have successfully saved your starter emergency fund amount you can go back and add more later on.
2. Get Yourself On a Budget
Getting yourself on a budget is the first thing you need to do when starting to manage your money and hit your financial goals.
And don’t let this step trip you up – a budget is just a plan for what you’re going to do with your money.
It doesn’t have to be restrictive or look a certain way. Your budget should match your priorities and be focused on your personal financial goals. There’s no right way and no wrong way to budget – as long as you’re doing one!
Without a budget, you won’t be able to know how much money you can send to your emergency fund each time you get paid.
Doing a budget will make sure you have the money to cover your bills, decide how much to set aside for spending, and how much you can send to goals like paying off debt or saving your emergency fund.
If you need help getting started with a budget, I highly recommend you check out these posts:
- How to Write Your First Budget
- Step-by-Step Guide to Budgeting in Excel
- Manage Your Money With a Printable Budget Binder
3. Automate Your Savings
Setting up my savings to transfer automatically was probably the best decision I ever made for my savings goals.
Either set up a second direct deposit at work (if you’re able) or set up an auto transfer to a savings account at your bank to happen on payday. If you never see the money in your checking account it will be like it was never there.
When you don’t have to transfer the money manually to your savings, you can’t be tempted to spend the money or use it for something other than your emergency fund.
4. Evaluate Your Progress
I definitely recommend using some sort of tracker as you save toward your emergency fund so you can easily see your progress.
It helps you stay motivated as you see the balance in your savings account increase.
I am a very visual person, so I usually like to use a tracker I can color in each time I make a transfer to my savings.
You could also set up a simple excel spreadsheet to track each deposit you make and the total. Or you could just watch the balance of your savings account go up.
However you choose to review your progress, make sure to do it on a regular basis so you stay motivated to reach your emergency fund savings goal!
What To Do After You’ve Built An Emergency Fund
Once you’ve worked hard to save up an emergency fund – don’t touch it!
Remember, this money is meant to give you peace of mind if something unexpected happens. Get your automated savings set up and then pretend that money isn’t there until you have an emergency.
Think of your emergency fund as insurance you pay into to cover whatever life throws at you. You can’t use your car insurance for anything except a car accident.
You can’t use your emergency fund insurance for anything but an emergency!
Conclusion
Saving an emergency fund is the number one thing I’d recommend doing to improve your finances this year.
Now that you know why an emergency fund is so important and how much you should have, it’s on you to get started saving!
If you have any questions or need some encouragement, make sure to drop me a note in the comments below!
And check out these other posts I think you’ll enjoy:
- Should You Save Money While Paying Off Debt?
- 7 Tips on How to Save Money and Reduce Spending
- How to Get Started Managing Your Money
