By their nature, emergencies strike at inconvenient times. A car breakdown before a vacation, or a medical emergency while you’re on the way to a relative’s wedding. We can’t know what these unwelcome surprises might bring or when they’ll happen, but we can plan for them. One way to do that is to build an emergency fund.
What is an emergency fund?
An emergency fund is a savings account with the sole purpose of covering unexpected expenses that arise in unforeseen situations. An emergency fund should not be confused with long-term savings for things like college tuition, a new car or a new home. Instead, this fund is a financial safety net for use only during genuine emergencies, like sudden medical bills, home repairs or job loss. By maintaining an emergency fund, you can better navigate unexpected financial challenges without derailing your long-term savings or going into debt.
Why should you have an emergency fund?
Life is unpredictable and emergencies can happen at any time. Whether it’s travel for a family emergency or even a natural disaster like a fire or flood, at times like these, having an emergency fund ensures you’re financially prepared to handle sudden situations without needing to add to your credit card or borrow from family and friends.
Without an emergency fund, many people resort to credit cards or loans that carry high-interest debt that is challenging to pay off.
How much money should you save?
To determine the right amount to save for your emergency fund, consider factors including your lifestyle, monthly expenses, income, budget and family size. As a general guideline, experts recommend aiming for a savings cushion equivalent to three to six months’ worth of living expenses.
That amount might seem challenging, but the key is to start small by setting aside a portion of your income regularly. If you don’t have much income leftover after covering your living expenses, you could start small with a goal of reaching $500, which could be achieved by saving just $10 per month over several years.
For guidance in setting a goal for your fund, a monthly budget calculator can help. Once you set your goal, you can solidify your new monthly budget and set up automatic transfers into your emergency fund.
Where should you save your money?
It’s best to store your emergency savings in a bank or credit union account that earns interest, like a money market or savings account. This enables you to earn interest on the funds while having the ability to withdraw money when you need to without facing taxes or penalties.
Placing emergency savings in assets like mutual funds or stocks means you risk having to withdraw funds during a dip in their valuation and take a loss. That’s to be avoided, as is using certificates of deposit (CDs) or Individual Retirement Accounts (IRAs) for your emergency fund. These accounts may carry early-withdrawal penalties, and you want to be able to withdraw the money you need for an emergency at any time penalty-free.
Using your emergency fund
Remember the key word in emergency fund: emergency! Avoid using your emergency fund to pay for foreseeable expenses such as taxes and regular home or car maintenance. When unexpected costs do arise, though, don’t be afraid to use this savings because that’s what it’s for.
To maintain a reliable emergency fund, make sure to replenish it during stable financial periods once you have had to use the money.
For information on how to start an emergency fund and to view savings account and interest rate options available with Bellco, visit our rates page.