April 26, 2021

Why You Need an Emergency Fund

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Everything you need to know about emergency funds, including why you need one, how much to save, and where to keep your fund for safe, easy access.

Think you can't prepare for the unexpected?

Enter: the emergency fund. It's the single best way to protect yourself, your loved ones, and your finances in the event of an emergency.

But how do you start saving? And when should you dip into it? This guide breaks down 10 important uses for an emergency fund, plus how much your fund should be.

What Is an Emergency Fund?

An emergency fund is a sum of money you save up for unexpected expenses. These can include medical bills, home repairs, or any of life's unanticipated financial burdens.

How much your fund should be depends on your monthly expenses and risk factors. And where you stash it is up to you, but usually involves a safe, accessible savings account.

Continue reading to learn why absolutely everyone needs an emergency fund (and how to save up as quickly as possible).

10 Reasons You Need an Emergency Fund

If you're saving for a home, wedding, or retirement, you might ask yourself: why should creating an emergency fund be a top priority?

1. Lower Your Debt Burden
If you don't have an emergency fund, every unexpected expense will require you to take on debt. You might borrow from friends or family, rack up your credit card debt, or take out a personal loan.

However, an emergency fund is the safest, most ideal way to pay for the expense. You don't have to pay it back with interest and can replenish the fund in your own time.

Did You Know? The average American has $6,028 of credit card debt, and less than half pay off their bill in full each month (47%). The notoriously high interest rates of credit cards makes this debt extremely difficult to overcome.

2. Protection from Job Loss
Job loss can happen for many reasons outside of performance. The company downsizing, redundancies after a merger, an economic downturn, etc.

Emergency savings enable you to cover several months of expenses while job hunting. Plus, it gives you the time to weigh your options, instead of taking the first available opportunity because you need the money.

3. Guard Against the Loss of Your Business
Similarly, if you own a business, you know how razor-thin margins can be. Your emergency fund can protect you from devastation in the event that your business is forced to shut down.

4. Cover Home or Auto Expenses
In 2018, the average American spent nearly $5,000 on home repairs alone.

If you own a home or car, you know unexpected damage, replacing parts, and maintenance can be expensive. An emergency fund can help protect your home and vehicle.

5. Pay for Medical or Dental Bills
When medical or dental issues arise, they can be costly to fix. An emergency fund can make sure you're not sacrificing your health and well-being due to financial instability.

As an alternative, you could open a healthcare savings account (HSA) to save specifically for medical costs.

6. Lower Financial Anxiety
If you have little or no savings, it can be nerve-wracking. It comes as no surprise that finances are a leading cause of stress and anxiety — especially among Millennials.

Building savings provides breathing room and peace of mind.

7. Increase Your Personal Freedom
Having a sizable emergency fund gives you financial freedom when money is tight.

Granted, these things might not qualify as an emergency. However, things like a friend's wedding, baby shower, or birthday mark important milestones that would be hard to miss.

An emergency fund allows you to maximize your financial freedom when you otherwise wouldn't be able to.

8. Pay for Medical Expenses for Children or Pets
When you have a beloved child or pet who runs into health problems, your main priority should be getting them the help they need — not how you're going to pay for it.

As both pediatricians and vets can come with a hefty price tag, emergency savings can help cover these expenses.

9. Cover Funeral Expenses and Travel Costs
When tragedy strikes, you want to be there to support your friends and family, both personally and financially.

An emergency fund can help cover costs like traveling to a funeral, paying for end-of-life expenses or assisting loved ones you just need cash to get by.

10. Meet an Unexpected Tax Burden
Tax season can bring along some unpleasant surprises. Maybe you find out you owe the government money at the end of the year instead of getting a refund.

On top of that, the money is owed in one lump sum. You can use your emergency savings fund to keep Uncle Sam from knocking on your door.

How Much Should an Emergency Fund Be?

An emergency fund should be enough to cover your monthly non-discretionary expenses like rent, utilities, and food.

Things like eating out, streaming services, or "extras" like gym memberships are not included in your emergency fund.

So how big should your emergency fund be? This calculator will give you your ideal amount.

If you're wary of saving this much, start by setting small achievable milestones. First, aim to save $1,000, then $2,500, and so on.

How to Build an Emergency Fund

Building an emergency fund takes time, but small and consistent contributions can add up to huge savings in the long run.

For example, if you save $75 a week for 5 years, you will have saved $19,500. That's easily enough to cover six months of expenses for many individuals and small families.

Here are 5 ways to fund your emergency account faster.

  • Automate savings each time you get paid. It's easier to save when you pretend you don't have it in the first place, and automated savings features alleviate hassle since you don't have to regularly transfer funds between accounts.

  • Set specific goals like the small milestones stated above — and reward yourself for achieving each of them with a modest celebration.

  • Cut back. Examine your monthly spending and monthly bills to find areas of wastefulness, such as subscription services you don't use anymore. Cut this spending and apply the savings directly to your emergency fund each month.

  • Invest your money in high-yield accounts (more on this later).

  • Save unexpected windfalls like your annual bonus, tax refunds, or other large sums of money that are not accounted for in your monthly budget.

Where to Keep Your Emergency Fund

There are two things you want from your emergency fund account:

  1. High liquidity
  2. High APY

Liquidity refers to how easily you can access and use your investments. For example, cash and checking accounts are extremely liquid, because you can use this money immediately.

On the other hand, owning a home may add to your net worth, but because you cannot access and spend the value of your home quickly, this is considered an illiquid asset.

Annual percentage yield (APY) refers to the percentage of interest your money earns each month. High-yield accounts put your money to work by accruing interest each month, so even if you don't add money into your account, your balance will still go up on a monthly basis.

So, where should I keep my emergency fund?

The best place to keep your emergency fund is probably a high-yield savings account. It keeps your money safe and easily accessible while earning modest interest.

However, there are other options to consider, depending on your desired liquidity and returns. See where else you might keep your fund in our complete guide here.

The Bottom Line

While many Americans are unprepared for an emergency expense, it doesn't have to be this way. Saving small amounts every month for emergencies is a smart choice for everyone who does not want to live with the daily anxiety of financial stress.

For more information on investing your money beyond an emergency fund, check out this article.

Write to Justin Barnard at feedback@creditdonkey.com. Follow us on Twitter and Facebook for our latest posts.

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