When it comes to spending, there are two main categories of large expenses. There are expenses that you plan for, saving up for weeks, months, or even years, such as weddings or paying for college. Then, there are the unexpected expenses. It could be a sudden added expense on top of your existing budget, like car repairs or medical costs. Or you could abruptly lose your job and be unable to pay for your ongoing monthly expenses. When these situations arise, it’s important to have an emergency savings fund.
Define Emergency Fund
An emergency fund is a dedicated amount of money set aside in case of a sudden loss of income or unexpected expense. While your emergency savings can be any amount, many people calculate their emergency fund amount based on their typical monthly expenses for a set period of time. You should build up your emergency savings separately from other saved funds, and avoid using it for everyday expenses.
Why You Need an Emergency Savings Fund
Emergency funds can help you avoid going into debt in times of crisis. If you have planned carefully, you may already have the money you need to pay the expense, which could reduce your stress during what will likely be a tense time in your life. Without an emergency fund, you may have to use an alternative payment option, such as a credit card, which could take a longer time to pay back, as well as accruing interest over time.
Emergency Fund Amount
There is no set dollar amount for an emergency fund, since expenses vary by person. A good rule of thumb is to have at least 3 months of regular expenses saved in case of emergency, or up to 12 months of expenses. Multiple factors affect how many months of expenses you want to save for, including:
- Type of employment – Does your company regularly lay people off? Is the field you work in competitive? How long might it take you to find another job if you were unexpectedly out of work? Depending on the risk related to your job, you may consider saving for a longer period of time.
- Life milestones – Are you single, or married with kids? Just starting out or moving towards retirement? Your age or the number of people in your family could raise the risk that you’ll face an unexpected expense, or affect your ability to repay it.
- Comfort level – How many months do you want to save for? Choose an amount that will give you confidence in case of crisis, but that you’re comfortably able to build up over time from your current income.
Calculate your emergency fund amount by adding together your monthly expenses, including food, loan payments, rent, utilities, and other bills. This amount doesn’t need to include extras, like entertainment, since you would likely cut back on optional costs in an emergency. After you have a monthly expense amount determined, multiply by the number of months you would like to set aside in emergency savings. Then, start working towards your savings goal!
Emergency Savings Account
To help keep your funds separate and avoiding dipping into your emergency savings for everyday purchases, consider opening a dedicated emergency savings account. Having a separate account could help you build up your emergency savings, particularly if you utilize key online banking features such as AutoSave. It’s important to choose an account that you can easily access, so it may be prudent to choose a savings account over an investment option such as a certificate of deposit.