5 Rules for an Emergency Fund That Will See You Through (Almost) Anything
An emergency fund may go by many names, but at its core, it’s an economic essential for anyone seeking financial independence. The emergency fund—similar to, but not always the same as, an emergency safety net—is a cash cushion against financial hardships such as losing your job, getting evicted or getting in an accident; it’s the financial life preserver that keeps you afloat during rough patches.
“When we think of an emergency fund, we simply want to make sure that someone has cash on hand for anything that’s unexpected,” says Lauren Anastasio, CFP at personal finance company SoFi. “Whether it’s a matter of getting you from one paycheck to the next, transitioning from that lifestyle of living paycheck to paycheck, or something a little more substantial, like the ability to support yourself should you lose your job, it really can serve in a variety of fashions.”
Everyone knows, on some level, that it’s important to have some savings to use in case of emergency; what those savings look like, where they’re stored, and what they’re used for are aspects of the emergency fund that aren’t quite as clear, though. To help clear up some of the confusion, Anastasio answered our major questions about emergency funds. With any luck, her smart, accomplishable advice will have even the least financially savvy among us moving a little closer to that most essential of financial goals: establishing an emergency fund.
A few reminders first: Everyone is different, and all financial situations are different. Some people have plenty of financial support from their families; some are facing student, medical, or credit card debt (or a mix of them). When reading personal finance tips, it’s important to consider everything within the context of your personal financial situation and do what’s best for you.
Ready to save? Read on for some rules for the emergency fund you’re going to want to start working on, stat.
- You need a savings goal to work toward
It should be specific, too. Telling yourself you’re just trying to save money isn’t enough. Give yourself a nominal (and realistic) savings goal for your emergency fund, write it down, and work toward that. When you reach it (or get close) you can raise it as needed; the important thing is to have a goal.
“Part of the reason having a goal in mind when you’re saving is so important is to make sure that you stick to your plan to save up for whatever that goal might be, to make sure that you’re accomplishing it,” Anastasio says. “Once you lose sight of what you’re trying to do by saving, that’s where people kind of derail and start to justify spending more money in the now, as opposed to making sure that money is being set aside for something specific.”
A savings goal or a financial goal—whatever you want to call it—can keep you motivated and on-track, just like setting a fitness goal to run a race or lift a certain amount of weight can keep you active. Ideally, it’s specific; “I’m trying to save $1,000” is much more motivating than “I’m trying to save for an emergency fund.”
Some banks—or financial companies such as SoFi—offer free one-on-one consulting sessions with expert advisers who can offer guidance on how to prioritize savings goals; if you’re struggling in this area, checking to see if your bank offers this kind of service can help set you on the right path.
- Three to six months’ worth of expenses is still the benchmark
For years now, the most common goal for a fully funded emergency fund is to tuck away the equivalent of three to six months of your expenses into savings, and Anastasio says this is still the case.
“It has been the default guidance for many years, and I think it remains appropriate for the majority of the population,” she says. “The two factors that I always encourage people to consider when they’re trying to figure out what’s right for them are how they define an emergency and if they have personal circumstances that might make something like 8-12 months more appropriate.”
This is where the context of your financial situation is so important: Most people can get away with just three to six months’ worth of their expenses (rent or mortgage, car payments, bills, groceries, etc.) in savings, but someone who is the sole provider for his or her family, self-employed, or has a chronic medical condition may be better off with a larger emergency fund.
“At the end of the day, we want to make sure that people have enough to cover them in the event of an unforeseen expense,” Anastasio says. “If someone needs more to feel safe or to feel like they’ll be covered, that’s okay.”
- It should be liquid
Some people invest their savings; others keep them under the mattress. Whatever you do, just remember that you need that money to be liquid: Should disaster (a layoff, sudden illness, a car breakdown) strike, you want to be able to access that money quickly without paying fees on it.
Maybe you have six months’ worth of expenses saved, but three months is invested; that’s all right, as long as you can access a sizable chunk of cash when you need to. You do want to make sure that money isn’t at any risk (as it would be in the stock market, for example). CDs, low-risk investments, Roth IRAs, and the like are all popular picks for emergency fund storage, but Anastasio recommends savings accounts for the easiest access to your money.
- Keep it in a high-interest savings account
Yes, your emergency fund should be liquid, but that doesn’t mean it should languish. Keep in mind that the value of that money can fall as inflation occurs and balance that concern with keeping your money accessible. (That’s the whole point of an emergency fund, after all.)
“We always recommend that an emergency fund go into a high-yield savings account, or something like SoFi Money, where you have very quick access to the cash and are ideally earning as much interest as possible, but not taking up any risk or locking it up in a way that it would be difficult to get to or where you would have penalties,” Anastasio says.
Interest rates for savings accounts have been on the rise the last few years; right now, a good rate is somewhere between 2 and 2.5% APY. Shop around for a good rate (ideally, without tacked-on fees) for keeping your emergency fund at the ready.
- Remember why you have an emergency fund
Even once you’ve successfully built an emergency fund, forgetting what it’s there for can derail your hard-earned financial success.
“All of our savings are there to serve a purpose, or maybe to accomplish a goal for us,” Anastasio says. “Keeping those goals in mind will help people stay on track in the future. It’s when we lose track of why we’re saving that money or what that money is designated for that we get in the pitfalls along the way.”
In the case of emergency funds, the purpose is to keep you financially afloat during rough periods. Putting that money toward something else—such as a vacation or a wedding—can put you on unstable financial footing should some disaster strike. Staying on track means defining what constitutes an emergency and sticking to that definition.
“What is an emergency to one person might not be an emergency to someone else,” Anastasio says. “I do try to remind people that a sale is not an emergency. Wanting to get out of town for the weekend is usually not an emergency.”
Setting aside money in a separate spot for those goals is smart, but dipping into that emergency fund to cover them isn’t. Be honest about what an emergency is for you, and you’ll be able to rely on your emergency fund in case of emergency for years to come.
Source: Lauren Phillips of RealSimple.com