How would you make ends meet if your family experienced a job loss? If one of you developed a serious illness, would you be able to pay the medical bills? Though challenges such as these occur without notice, you can be prepared to handle their financial implications by diligently creating an emergency fund.
My husband and I are not financial experts and we’re certainly not wealthy, but we’ve successfully built up an emergency fund over the last year and we’ve learned some valuable lessons in the process.
Why have an emergency fund?
The consequences of facing an emergency with too little in savings can be dire. It might mean defaulting on your mortgage. It might mean accruing debt that will be with you for the rest of your life. It might mean having to choose between paying for groceries, utilities, or a medication.
How much should be in an emergency fund?
Financial experts haven’t exactly reached consensus on how much should be saved in an emergency fund (recommendations range from a few hundred dollars to 12 months’ living expenses). However, the most common recommendation is to save 3 to 6 months’ living expenses.
How to build an emergency fund
It’s hard to imagine putting even a little money in savings when you’re living paycheck to paycheck; saving 3 to 6 months’ living expenses seems downright impossible! However, with a little creativity and a lot of diligence it can be done. Here are some ways to save money, earn money, or reallocate existing earnings in order to build an emergency fund.
- If you have direct deposit at work, have your employer deposit a portion of your paycheck (even if it’s small!) into a savings account.
- Take on babysitting, housesitting, or dog walking jobs for family, friends, and neighbors.
- Gather unneeded items in your home and sell them on craigslist or at a yard sale.
- Go on a 30-day spending diet. Give up your daily latte, weekly dinner out, or monthly visit to the movie theater.
- Keep a change jar or piggy bank on hand to collect spare change. It can really add up!
- Bargain shop for clothes and household items at thrift stores, garage sales, and flea markets.
- Get new quotes on insurance policies. You might be able to save by switching to a new policy or company.
- Put your income tax refund into the emergency fund.
Where to store your emergency fund
Clearly you don’t want to tuck a bunch of cash under your mattress or keep it in a jar in the freezer. It should be securely stored in an account that is easily accessible. Many people find it useful to store the money in its own account (this is what we do, but you can certainly keep it with money designated for other purposes as long as you’re organized enough to know how much money is considered to be emergency funding).
A savings account is generally a better place to store the money than a checking account because it’ll earn interest, even if it’s a small amount. Another good option is a money market account, which will likely earn more interest than a traditional savings account. Check with your bank to find out the minimum balance on a money market account and any restrictions on withdraws or transfers. Some people place their emergency funds in CDs. This is a viable option for some, but carefully consider the minimum deposit, the fixed term of the deposit, and the penalty associated with early withdrawal.
What constitutes an emergency?
An often overlooked task associated with the creation of an emergency fund is determining what constitutes an emergency. It’s best to decide this now instead of waiting until a potential emergency occurs. In my household, we consider the following situations to be “emergencies” that warrant the use of emergency funds.
- Job losses
- Medical or dental emergencies
- Major home repairs that cannot be put off (e.g., damage due to a natural disaster, a leaking roof)
- Major car repairs (if both cars are incapacitated—we have 2 vehicles, so we could manage with one before dipping into emergency funds)
- Bereavement-related expenses for loved ones
We do not consider things like vacations, investment opportunities, or home improvement projects to be emergencies.
Do you have an emergency fund? In what sort of account do you store it? How were you able to save money to build up your fund?