Emergency Funds: What You Need to Know

Personal finance experts disagree on a lot of things, but having a fully-funded emergency fund is one thing that they all get behind. And for good reason.

Life happens! Maybe you've noticed? 

Sadly, according to a survey by Bankrate in 2020, nearly 4 in 10 Americans would not be able to cover a $1000 emergency without borrowing. 

And you would be forgiven for thinking that financial emergencies are uncommon. Within the last year alone, 28% of Americans experienced a financial emergency. 

The moral of this story? 

If you want to change life's unexpected circumstances from crisis to mere inconveniences, then you need an emergency fund to bail you out. 

It can be especially crucial to have a financial buffer if you are already in debt to avoid relying on high-cost solutions such as credit cards. With the average credit card interest currently at 16.12%, you probably ( definitely? ), want to avoid being in a position of having to borrow during an emergency. 

There are no two ways about it - Having an emergency fund is the backbone of any financial plan.

Keep reading to find out tips on contributing to your emergency fund, how much you need in your emergency fund, and where to keep the money. 

How much should you have in your emergency fund?

Ideally, the goal is to have about 3 - 6 months of your essential expenses in your emergency fund, but a good place to start is a $1000 emergency fund, which can cover basic emergencies.

That said, with the average cost of an emergency in 2020 at $3,518, it is evident that a $1000 emergency fund should only be the beginning. Grow your emergency fund over time to fit your and your family’s needs. 

Remember, this is your financial plan and your emergency fund. There is no wrong amount to save for your emergency fund, as long as you hit the 3 months of essential expenses minimum that is recommended. Some people save 3 months of expenses, others up to 3 years of expenses. When deciding what works for you, think about your risk tolerance, financial goals, the health of your family - anything and everything is fair game to factor in. The goal is for you to feel comfortable about what you have stashed away for a rainy day. 

Where you should put your emergency fund?

It is often a good idea to keep your emergency fund separate from your main bank accounts - that way you avoid the temptation to dip into it for everyday expenses that don't count.  

You also want to have instant access to the fund when an emergency strikes, so you don't want to put tie it up in investments. 

It is highly recommended to use a high yield account for your emergency fund. That way you can also earn at least a little bit of interest to try to ward off the effect of inflation, and have quick access to it. 

Tips on how to build your emergency fund 

1. Incorporate emergency savings into your budget

It doesn’t matter if you’re living pay-check to pay-check or earning a six-figure salary. If you want financial security, you'll need to understand where your money is going. 

Unlike what you might have heard, budgeting isn’t about restricting yourself. On the contrary, budgeting actually gives you the freedom to spend money on the things you love.

Because it is so versatile, a budget can also help you plan for emergencies. Once you determine how much you would like to save towards your emergency fund, include this financial goal in your budget, and try to stick to your budget. 

I won’t lie and tell you that it will be easy to stay on track with your budgeting efforts. If it was, everyone would consider themselves financially secure (on the contrary, according to a recent study by Fidelity, 60% of Americans are concerned about their finances).

What I can tell you is that your future self will be very thankful if you take the time and effort to beef up your emergency fund.  

Related: 7 reasons why you absolutely need a budget 

2. Acknowledge your milestones

Motivation goes a long way in helping us achieve our goals. This is also true in financial goals. Set up some milestones towards your emergency fund goal then acknowledge and reward yourself for your efforts when you hit them.

Now, hold your horses, before you go on throwing a $1000 party for hitting a $5000 milestone, that’s not what I am saying. 

Instead, incorporate small amounts of money for indulging when you hit your  monthly or quarterly milestones.

Related: How to set SMART financial goals

3. Automate your finances

Automating finances is one of the best and most effective money-managing practices. 

So what's the secret to behind it?

Automating savings and investments takes away emotions (and oh, there can be so many emotions when it comes to money) so it is easy to incorporate into your current financial strategy.

And get this: Automating your finances is particularly effective when working towards a savings goal, managing recurring bills and in your debt payoff strategy. This has to be one of my favorite ways to save towards a financial goal! 

4. Stop living beyond your means

4,000 to 10,000 advertisements. That's the number that digital experts estimate most Americans are exposed to - per day!

It's a familiar story, and it usually ends like this, 'I just don't know where it all went.' 

Yes, I hear you. I know how easy it is to spend in today's culture. To compare our financial situations to those of our families, friends or neighbors. 

Turns out there's even a psychological aspect to this social pressure. Some psychologists call it the herd instinct. Basically, our brains are designed to try to make us fit in. 

And just like that, too many people spend money they haven’t earned to buy things they don’t want to impress people they don’t like.

It is no wonder the average person's credit card debt is a staggering $5313! 

But if you're sick and tired of spending money you don't have, it is time to buckle up and get your house in order. 

OK, so you might not want to pass on that 3rd happy hour for the week that you know will cost you another $50. But when you remind yourself that you're saving up for that house down payment, it will be much easier to ask your friends to join you for some (more affordable) drinks at home.

Related : 5 Signs That You Are Living Beyond Your Means

5. Save any excess unallocated money

Extra unanticipated bank refund? Save! Random $200 check from your favorite uncle? Save!  Bonus at work? You know it...save, save save! 

Extra unplanned income is a great way to save towards your emergency fund. We can often find ourselves splurging when it comes to unexpected income, but perhaps while working toward an emergency fund, it might be worth it to rethink priorities. 

Final Thoughts

There is no doubt that whether a personal emergency fund or even a small business emergency fund, having an emergency saving fund is crucial for financial success.

If you don’t have one yet, you might want to start building an emergency fund as you work towards financial freedom, whatever that looks like to you.