How Emergency Funds Work

Life is, unfortunately, full of left-field moments and crises. Car accidents, medical emergencies, and losing a job are just a few of the most common hardships that can impact us. But as tough as these are to deal with on the surface, they can also be expensive. For this reason, it’s smart to set aside money to help pay for situations you can’t see coming.

This article will detail the basics of emergency funds, including explaining their benefits and how you can start building one. We’ll also offer some pointers on when you should and shouldn’t use one and how it may be helpful to work with a financial advisor.

What Is an Emergency Fund?

An emergency fund is any money you set aside, often in a bank account, to cover unanticipated and costly expenses. This could be for a variety of the unforeseen events life could throw at you, such as:

• Losing a job
• Medical emergencies
• Car repairs
• House repairs
• Divorce
• Death
• Travel

Why Start One?

Maintaining a healthy fund for contingencies allows you to avoid significant stress and financial hardship associated with many events. It lets you take a calculated approach towards life, understanding that you can handle the dangers that can or may happen at some point.

Here are some primary benefits of saving for emergencies:

• Peace of mind. It lets you know that, even if a crisis occurs, both you and your family are financially prepared to handle it.
• Avoid financial ruin due to unforeseen events. Many emergencies are expensive and can rack up huge costs. Saving ahead of these events can help you dodge serious financial problems.
• Avoid dangerous ways of paying for incidents. When facing expensive payments, such as for home repairs or medical events, it’s tempting to use a credit card, even if it means incurring high-interest debt. Instead of taking this risk, you can use your savings to handle the costs.
• Keep track of your budget. As you set up your fund and add to it, you’ll likely gain a more in-depth awareness of your monthly budget. This may help you save for other goals, such as retirement.

How to Start an Emergency Fund

Keeping a large sum of cash on hand for emergencies may seem daunting. In many cases, it might also feel like it’s burning a hole in your pocket when you check your bank balance. With a little discipline, however, it’s usually simple to stow money away, even if it’s only small amounts at a time.

Below are some key strategies to keep in mind as you save for contingencies:

Save to Cover Three to Six Months’ Expenses

If you’re considering putting together an emergency fund, you may wonder how much you need to save. While the exact number can vary, there is a common rule of thumb that financial planners and advisors often recommend to clients.

“The general recommendation is to have three to six months’ worth of living expenses in an emergency fund,” says Taylor Kovar, CFP, founder and CEO of Kovar Wealth Management in Lufkin, Texas. This can provide you enough buffer to both deal with the incident and, if it affected your daily life, allow you time to recover and get back on your feet.

The amount you’ll need to save up will depend on several factors unique to you. Per Kovar, “[Factors] like job stability, number of income earners in the household, health, and personal risk tolerance can influence” your saving strategy. “For instance, freelancers or those in volatile job markets might aim for a larger fund, while those with stable jobs and good health insurance might be comfortable with a smaller fund,” he continues.

Contribute Regularly

Making consistent and recurring contributions to your emergency fund is an effective way to build it up over time. This means you would allocate a certain amount of money to your fund each month or year and create a payment schedule.

According to Kovar, “Regular contributions are essential to building and maintaining an emergency fund. Ideally, one should contribute monthly, treating it like a non-negotiable expense.” For instance, you may choose to lay aside $100 to $200 each month. While this doesn’t seem like all that much, it can add up and eventually build a decent-sized pool of money for emergencies.

By saving each month, you can factor your contributions into your monthly budget and treat them as money that’s assumed to be gone, much like you would for your utility bills or groceries. “Automating these contributions can help ensure they are made regularly,” recommends Kovar.

As you save, keep in mind that the monthly amount you put away should be something you feel comfortable giving up. It should never put strain on your current well-being, even if it’s for a good cause.

Keep it Accessible

Finally, it’s vital to ensure your emergency savings are always at your fingertips. That is, if an accident happens where you need to dip into your contingency account, you should be able to easily withdraw the money you need or move it to your checking account within a day or moment’s notice.

What types of accounts are best for accessibility? Kovar says, “High-yield savings accounts are a popular choice as they offer higher interest rates than traditional savings accounts while still providing liquidity.” Placing your money in these accounts also allows you to take advantage of compound interest, which may help you save more rapidly and efficiently.

It’s often not a recommended strategy to place emergency cash in the stock market or with fixed-income investments such as bonds. The problem with this is that it can be difficult to pull your money out when you need it. In some cases, you may also risk losses if you must sell them at the wrong time. “The goal is to keep the fund safe and accessible, not to generate high returns,” Kovar emphasizes.

When to Use It

As mentioned, emergency funds are for unplanned life events that require large payments to deal with. In many cases, we all know an emergency when we see it. We can often feel the stress on top of the financial hardship. Common examples, Kovar notes, are “medical emergencies, necessary home or car repairs, or living expenses during a job loss.”

Just as important as knowing when to wield your savings, is being clear on when not to use it. While it’ll ultimately be up to you to decide what you consider to be an emergency, it’s best to use the fund only when you need it. In other words, it’s probably not the best idea to make a withdrawal if you want to buy a new car or even if you want to spend extra on groceries.

Kovar stresses, “It’s not advisable to use these funds for planned expenses, non-essentials, or investment opportunities. The purpose of the fund is to provide a financial safety net for genuine emergencies, not to supplement regular spending.”

How Financial Advisors Can Help

Assembling a saving strategy will likely intersect with many pieces of your financial strategy. While it’s generally simple to save a little bit each month, it’s often a good idea to consult with a financial advisor before you get started. They can provide more clarity on what you need to do to begin building your emergency savings.

In the context of building a contingency fund, a professional will be able to assess your goals and circumstances, including your income and budget. Then, they’ll help you arrive at an ideal saving total per month, as well as help you come up with concrete targets (i.e., the three to six-month expense rule).

The most ideal types of experts to seek out in this case would be those who focus on planning and consulting, as these have specific experience working with clients on all components of their finances. The highest quality of these are those who follow a fiduciary standard, such as those with the Certified Financial Planner (CFP) or Chartered Financial Consultant (ChFC) titles.

One of the quickest ways to find a financial advisor is by using a matching tool, such as this free one. It will ask you a short set of questions about your needs and situation, and then it will present you with up to three reputable experts near you.

Frequently Asked Questions

How much money should be in an emergency fund?

Financial experts often recommend saving three to six months of expenses. This gives you a stronger chance of not running out of money or needing to take on debt because of an unforeseen accident or disaster.

How often should I contribute to my emergency account?

It’s a good idea to contribute to your emergency account monthly. This lets you part with smaller amounts of money at a time, which is less likely to hurt your current financial situation. It’s worth noting, though, that while this schedule is ideal, you should only contribute when you’re able and comfortable.

Is a 12-month emergency fund too much?

Though 12 months of savings exceeds the three to six months rule we’ve mentioned, it’s not too much if you aren’t putting too much stress on your present well-being. Saving that much means you’d be able to be prepared for a wide range of scenarios and incidents.