An emergency fund is a savings account that is used primarily for unexpected or unforeseen expenses. There are things in life that no matter how careful you are with money you cannot plan for. That’s why it’s so important to set up an emergency fund. Some of the unexpected expenses that come up include:
- Hospital bills
- Car breakdown expenses
- Home repairs and replacements
- Sudden unemployment such as a layoff
- Catastrophes such as the pandemic
The goal should be to have at a minimum $1,000 in an emergency fund to start with. This is an achievable goal that can either be set up immediately or over. You can put $1,000 away now or start a savings goal to save it over time. According to survey done by CNBC only 39% of Americans have $1,000 in their savings account. This is a scary thought when you think of what could happen and the impact on our lives.
Once $1,000 is saved most people aim to save three to six months’ worth of expenses in the emergency fund. This is a great buffer for any unplanned life events that can happen because these savings can cover expense for up to six months without worrying about how to survive. It allows breathing room when trying to pay for unforeseen expenses.
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Is an emergency fund useful?
The short answer is yes! It is important to have an emergency fund to avoid having to borrow money from friends or family when unexpected expenses arise. With this money set aside you can also avoid getting into debt using credit cards or borrowing from high interest loans from the bank.
The rule of thumb is to ensure that you separate this fund from other savings account as it should only be used for emergencies. This means that if you run out of spending money you should not deep into the emergency fund for movie nights and such.
Setting up an emergency fund should take precedence over setting up other savings accounts, investments and even paying off debt. The reason is that the money you set aside will be needed immediately if any situation mentioned above arises and it should therefore be readily available.
How to set up an emergency fund
Decide how much to save
There are different amounts that you can decide to save depending on income, financial goals, and personal preference. At a minimum you should aim for $1,000 then you can build on that. After the first $1,000 has been set up in a separate account you can aim to:
- Save at least 3 months’ worth of expenses
- The next goal should be 6 months’ worth of expenses
- After this you could fund the emergency fund to have a year’s worth of expenses which is the ultimate cushion for unexpected life events.
Prepare a budget
The next step is to prepare a budget. The budget should include essential expenses that you have to pay for every month. These are the things you cannot live without. This is a great exercise to see exactly where your money goes. A great place to start would be your bank statements as you can easily see how much you spent and where.
Essential expenses include the mortgage/rent, taxes, insurance, utilities, water, phone payments, cable, internet, car payments, gas, groceries, health insurance, debt repayment. See how to create a budget and download the free template on this post.
Set up a savings goal
Create a financial goal that you can measure and that is achievable. What this means is that you should not start with a 6-month worth of expenses savings goal if you don’t have $1,000 set up because you will get frustrated. Set up goals that you can achieve and build on. Use a savings challenge to track how much you are saving and when. It will also tell you when you fall short.
Create a separate account
Your emergency fund should be set up in a high interest savings account where it will be safe. It should be readily and easily accessible when needed but also not used for everyday expenses which is why it should be separate from your regular savings account.
How to use the emergency fund template
The printable form is available here. Use the instructions below to calculate how much you need in your emergency fund.
- Fill out the different sections with the amounts that you spend each month. If in doubt check your bank statements for the past 3 months. They will give you an exact or average amount that you spend on each expense.
- Add up the expense to get the total for one month.
- Multiply the monthly total amount by 3 for the 3 month goal and then 6 for the 6 month goal.
