What Should Your Emergency Fund Look Like?

by Sophia Bera on January 28, 2015

Starting an emergency fund can sound like a daunting task. 3 to 6 months’ of your income, in one place? That’s a big number!

You may think you don’t even need an emergency fund. But don’t be fooled into this line of thought. After all, it’s hard to know exactly when an unexpected expense will pop up (but somehow it always seems to be at the most inconvenient times).

Emergency funds help protect you in case of any event, big or small. Car repairs, your basement flooding — or even a wild turkey in your living room all count as emergencies.

Imagine if you had a serious emergency right now: how much is in your bank account, and could you afford an unplanned $1,000 bill or expense? If not, it’s time to start thinking about earmarking some cash savings to see you through tough financial situations.

How Much Should You Keep in Your Emergency Fund?

You should aim to have at least one month worth of your net pay saved in your emergency fund. If your net pay is $3,000 a month, you should save $3,000 in your emergency fund before allocating money elsewhere. Do this before aggressively paying down debt.

Sound like an impossible amount to save? Remember, you don’t have to fully fund an account set aside for the unexpected all in one go. Save what you can each week, even if it’s just $25 — but prioritize your goals so your emergency fund receives the most attention.

Saving Based on Your Unique Situation

One month of your net pay is a general guideline. Once you’ve hit this goal, bump it up to 3-6 months of net pay saved for emergencies. For couples who make similar incomes, I generally recommend about 3 months, but for people who are single or the sole breadwinner, you might want to aim for 6 months.

If you’re a contract employee and your monthly income varies, you may want to save a little more in order to cover months when you’re working less and earning less. Consider saving more during the months when you have a lot of contract work, so that you will have more money to rely on in case an emergency happens during your lean months.

You can also focus on saving more if you have dependents or planning on adding to your family. While it’s tough to envision potential emergencies, your emergency fund should be able to cover a large deductible or co-pay in case of a family hospitalization.

Where to Put Your Cash Savings

The key to an emergency fund is accessibility. This is cash savings earmarked to cover short-term emergencies, so it needs to be kept in an account you can access immediately if necessary. There are three things to keep in mind when choosing a place to keep your emergency fund:

  • Liquidity
  • Accessibility
  • Low risk

Cash, savings accounts, money market accounts, and high yield savings accounts are all liquid, accessible, and are extremely low risk, but some options are better than others. Money market accounts typically offer a higher interest rate, meaning your money will grow faster than in a typical savings account. In addition, you can withdraw and write checks from your money market account, making it very accessible.

A high-yield savings account is very similar to a money market account because it is also easily accessible and offers a higher interest rate. Check out FDIC-insured online banks for the best high yield savings accounts, as they can offer better rates than brick-and-mortar banks.

I really like Ally Bank and CapitalOne 360 for places to stash your cash. These are online savings accounts that you can link to your already existing checking account. They offer some of the highest interest rates on money market accounts.

Above all, assess your risk tolerance. If you don’t feel comfortable keeping your money anywhere else but your local credit union savings account, keep it there! The bottom line is you want to be able to deposit money and access your emergency fund quickly when needed.

What to Do After Fully Funding Your Account for Unexpected Expenses

Once you’ve saved up 3-6 months’ worth of expenses (or more), continue building on your other financial priorities. These may include:

By establishing an emergency fund, you will ensure financial success for yourself and ward off financial catastrophe. Focus on building up your emergency fund to account for at least one month of net pay, then aim to have  3 to 6 months’ pay set aside.

The most effective way to save for your emergency fund is by setting up automatic withdrawal from your checking account. Consider starting out with $100 a month and increasing, if possible, from there. While you’re setting that up, you may want to keep your money in a high yield savings or money market account, so your savings can build up quickly if you don’t need it.

One of my favorite tips is to change your direct deposit at work so that a portion goes directly from your paycheck to your savings account. If you don’t see it, you won’t spend it!

Having an emergency fund will allow you to handle most of what life throws your way — without draining other accounts, interrupting progress on other financial goals, or forcing you into debt. It’s one of the best tools to use to help you build financial security and, eventually, independence.

Want to keep learning how to get on the right road to financial success? Start by grabbing your copy of my new ebook, What You Should Have Learned About Money, But Never Did: A Gen Y Guide to Empowered Personal Finance. The official release date is January 30th! Learn more here.

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