You’ve undoubtedly heard the good financial advice that everyone needs to have an emergency savings fund. But the specifics—particularly how much you should have tucked away—vary depending on who’s giving the advice. Because this is such an important topic, and because having an adequate emergency savings fund is one of the most basic signs of financial stability and security, we’d like to answer some common questions about it.
What Is an Emergency Savings Fund?
It’s exactly what it sounds like: a readily available sum of cash you have stashed away exclusively for emergencies like unexpected expenses or sudden loss of income. You don’t touch this money for any other reason. Think of it like having insurance.
Why Do I Need One?
Everyone eventually experiences unforeseen expenses. Medical or veterinary bills due to an illness or injury, car problems, home repairs, broken-down major appliances, and others are all common. They can cost many hundreds to many thousands of dollars. And there’s always the possibility of facing more than one at the same time. The other key reason to have emergency savings is to protect against loss of income. What would happen if you or your partner were suddenly laid off, became unable to work, or even died? You may feel secure if you have money in various places, but you certainly don’t want to sell a property or dip into your kid’s college savings or your retirement account to handle an emergency.
Where Should I Keep My Emergency Savings?
Money for emergencies must be entirely liquid for immediate access if necessary. Investment vehicles that require time (and often penalties) to make a spontaneous withdrawal are not appropriate places for emergency funds. While you could stash a large wad of cash under your mattress, this isn’t the smartest idea, as it’s not particularly secure. Emergency savings belong in an FDIC-insured savings account with a bank or credit union. High-yield savings accounts are best, offering the most interest; note that FDIC-insured high-yield accounts with online banks are just as secure as brick-and-mortar banks.
Should I Pay off Bad Debt First?
The interest on your credit card balances costs more than you’ll earn in interest with a savings account—even a high-yield one. So, it may seem to make good financial sense to focus on paying down debt before starting an emergency fund. But this isn’t the case. One of the most important principles when tackling credit card debt is first making sure that you’re free of your reliance on those cards. It’s usually not worth it to make a valiant effort to pay off credit cards when you’ll have to run up balances again as soon as you have an unexpected expense or loss of income.
Can I Put too Much into My Emergency Fund?
As we discuss below, you should calculate a specific amount to keep in your emergency savings fund. It’s helpful to consult a professional financial adviser when doing so. Because it is possible to overfund your emergency savings. While it’s important to have, you do lose money when you have funds simply sitting in a savings account. Even in a high-yield account, the interest doesn’t keep pace with inflation. And money in a savings account could easily be invested for higher returns. So, avoid putting an excessive amount of money into an emergency savings fund, as it’s wasteful and can even hinder your progress toward meeting other financial goals.
How Much Should Be in My Emergency Savings Fund?
Obviously, the answer to this question is highly personalized. Most financial experts recommend having enough money to cover somewhere between three to six months’ worth of your expenses. So, the answer depends on what your monthly payments are, and how much they total up to.
Other factors matter, too. How much are you comfortable putting into savings? How secure is your employment (and your spouse or partner’s)? Do you have extra security from a lot of assets and investments? Someone with relatively secure employment and many investments might feel fine having only three months’ worth of expenses covered by their emergency savings, while someone without these advantages may be better off with six months covered.
How Do I Get Started?
Even having a small emergency savings fund is better than having none. Many people don’t have the sum to simply set aside. So, open a savings account with as much as you can afford to start with. Often, you can find a special offer where a bank pays you a small amount when you open a new account with a certain minimum deposit and/or set up direct deposit. While it may be tricky if you’re on a tight budget, ideally you can set up a direct deposit or make a regular deposit from your paychecks until you reach your goal amount. Automating the process helps you stick with it. If necessary, find one or more weekly or monthly expenses you can cut and put that money into your emergency savings account instead.