As its name suggests, an emergency fund is money set aside to pay for emergencies. These can range from unforeseen healthcare expenses and home repairs to job loss or a natural disaster. Setting money strategically to prepare for financial curveballs can go a long way toward boosting your financial security.
1. Why you need an emergency fund
If you experience a job loss or sudden expense, an emergency fund can help you avoid relying on high-interest loans and credit cards to make ends meet. An emergency fund can also help you avoid the temptation to sell assets prematurely, missing out on potential future returns.
2. How much you should save
We recommend saving six- to 12-months’ worth of living expenses, sometimes more, depending on your household income, expenses, and overall situation. For many, saving as much as a full year’s living expenses can feel daunting—remember, it takes time to build up this type of safety net.
Rather than waiting for ideal circumstances before you start saving, we suggest starting now and starting small. You can start with as little as $100 and work your way up. Consider making recurring contributions from your paycheck or arranging a monthly transfer from your checking account. Consistency is often the most important part of building savings over time.
Tip: Try to set goals along the way. Think about your largest bill (perhaps, it’s your mortgage or rent payment), and note when you reach one-, two-, or three-months’ worth of payments. Additionally, put ‘bonus’ cash, like a tax refund or actual bonus, toward your emergency fund. These larger deposits can make a meaningful difference over time.
3. Where to keep your emergency savings
The simplest place to keep an emergency fund is often a basic savings account. However, the size of an emergency account (assuming you’ve hit your 12-month savings goal) can make a savings account unappealing. You don’t want that much cash to sit around without earning interest.
To combat this, we often recommend clients use a high-yield savings account with a competitive annual percentage yield (APY). Just remember: APYs often change based on financial conditions and at the discretion of the financial institution.
Other account options might include cash-equivalent accounts, such as money-market savings accounts or mutual funds. A financial advisor can help you select the best account for your situation.
Tip: Keep your emergency fund savings separate from other savings, such as a down-payment or vacation fund. Make sure whichever account you choose allows you to easily access your money without fees, penalties, or tax implications.
4. Supplement your savings with insurance
Many unexpected expenses—whether it’s a medical issue or home repair—may be covered, at least in part, by insurance. It’s one reason we recommend our clients review their insurance coverage annually, reviewing what situations are covered and the deductibles/out-of-pocket expenses, as well as premium costs. Some individuals tend to overlook the coverage in favor of a smaller premium, but it’s important to consider the long-term benefits of the insurance plan and what it covers when an emergency happens.
Still, even the best insurance policy doesn’t negate the need for an emergency fund. Claims can take a long time to process; it’s common for insurance companies to reimburse policy holders versus paying for situations directly. You want to make sure you have enough money to cover those expenses until a claim is paid.
An emergency fund is one of the most important components of a financial plan. It can help protect your long-term goals from short-term derailments. Perhaps, the biggest benefit of an emergency fund, though, is the peace of mind it can provide your family because you won’t have to worry about finances in an emergency.
