Explanation of what is an emergency fund

 Anyone who is unable to predict the future requires an emergency fund. They are the unsung heroes of a basic financial plan. But, what is an emergency fund? What size should yours be? Whether you're an experienced saver or just starting out, here's everything you need to know about emergency funds.

What exactly is an emergency fund?
Explanation of what is an emergency fund
an emergency fund

An emergency fund, as the name suggests, is where you save money in case of an emergency. What constitutes an emergency varies depending on who you ask, but some common examples include an unexpected medical bill or repair, a sudden layoff, and other unanticipated events with a cost.

What isn't considered an emergency expense? Costs that are out of the ordinary but predictable, such as a non-urgent medical procedure or holiday gifts. You should save for those unexpected expenses in a separate savings account and keep your emergency funds for true surprises.

You can keep your emergency fund in a variety of accounts. What matters is that it is kept relatively "liquid" (in cash or assets that can be easily converted to cash) so that you can access your money without losing much, if any, value when you need it quickly.

Why is an emergency fund necessary?

Emergencies are unpredictable and often strike when we are least prepared, both personally and financially. According to the Federal Reserve, more than 30% of Americans would be unable to cover an unexpected $400 expense. 

Many said they'd have to use a credit card to pay the bill because they didn't have any savings. If they do not pay the charge in full when the bill comes due, they may end up owing up to 20%2 more than their original emergency expense (based on average credit card interest rates), putting them further behind financially. In other words, the stress of being unable to pay your bills can compound alongside the interest.

That is the issue with emergency expenses. They have a way of compounding quickly, especially if you don't have a financial safety net. Even if you have some form of insurance (for example, unemployment benefits or health, home, or auto insurance), you may have to pay a deductible or wait weeks or months for a reimbursement check. Having a stash of emergency cash is therefore equally important for those who are otherwise financially prepared.

How much should my emergency fund be?

Calculating the exact amount of your emergency fund can be difficult, especially if you have no way of knowing how much a hypothetical expense might cost you. To give you a starting point, Fidelity recommends that most people save 3 to 6 months' worth of essential basic living expenses in an emergency fund. That's usually enough to cover a deductible or tide you over until you can find another job if you lose your current one unexpectedly.

You may choose to save more than three to six months' worth of expenses if you meet the following criteria:
  • Have any family members or dependents who rely on you financially?
  • Have certain circumstances that may result in higher-than-average costs, such as older homes or less-than-reliable cars
  • Are you working in a field where layoffs or inconsistent income are common?
  • Are retired or have a fixed income and anticipate or are in the midst of a large economic downturn that may cause periods of unemployment to last longer

What costs should you factor into your emergency fund?

Add up your monthly essential expenses and divide the total by the number of months you want to cover. When calculating your average monthly costs, keep the following expenses in mind:
  • Rent or mortgage payments, as well as utilities
  • Simple groceries
  • Premiums for health insurance
  • Child care and/or schooling
  • Transportation
  • Minimum monthly debt payments (e.g., student loans, car loans)
That excludes nice-to-haves like gym memberships, vacations, restaurant meals, and entertainment—basically anything you can (temporarily) eliminate to make your budget as lean as possible.

How to start an emergency fund

Life is already full of financial demands, so it may appear difficult to prioritize saving money for the unexpected when you're barely coping with the expected. However, putting $1,000 in an emergency fund as soon as possible should be your top priority. Here's where to begin.

  • Choose the best account for your emergency fund. Remember that in an emergency, you'll probably need to access your money quickly, so keep it in an account that won't charge you a penalty or a lot of taxes if you withdraw it. Learn more about your options in our companion guide to emergency preparedness.
  • Consider your emergency fund to be a monthly bill. That turns it into something you have to pay for and not skip when you'd rather go out to dinner and a movie.
  • Contribute automatically. Set up a direct deposit from your paycheck or think about regular automatic transfers from your checking account to your emergency fund. The less effort required, the more likely you are to complete the task.
  • Save all of your windfalls, large and small. Unexpected cash infusions, such as a bonus, tax refund, or credit card rewards, are ideal candidates for bolstering your emergency fund because you aren't used to having them in your budget.
  • Increase your savings rate by using your raises. By putting at least a portion of your new pay into an emergency fund, you can put yourself on a more solid financial footing and avoid lifestyle creep, which is the tendency to overindulge as your income rises.
  • Reduce your spending. As you go through your bills to figure out your average monthly spending, you may notice that you're overpaying for certain expenses or not taking advantage of subscriptions you signed up for (then forgot about). If you cancel or opt out of auto-renewals, put the money you save into an emergency fund.
  • Keep in mind that every penny counts. Consider a "round-up" savings option or app if you've already cut your expenses to the bone or simply want another easy way to bulk up your emergency fund. Then, every time you swipe your credit or debit card, the extra change goes directly into your emergency fund.
  • Refill as needed. If you ever withdraw money, make it a priority to replenish your savings account.
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Mira Sandra
Mira Sandra I am Mira Sandra. A blogger, YouTuber, trader, and owner of the blog Recordmeteo.com. Starting to know online business since 2014 and continue to learn about internet business until now. Currently active as a trader and content writer at Recordmeteo.com.

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