People who’ve had large and unforeseen expenses arise can probably tell you one of two things: how happy they were that they had an emergency fund or how difficult it was to find the money they suddenly needed. As with most finance-related issues, preplanning is a key factor in successfully weathering the storms we are all sure to face in life. According to the 21st Annual Transamerica Retirement Survey, the median emergency fund balance among workers is only $5,000, and only one in four Americans have no retirement savings either.
- An emergency fund allows you to live for a few months if you lose your job.
- Many financial experts suggest that you should save anywhere from three to six months’ worth of salary in your emergency fund but most Americans do not.
- It is hard to save if you are working a low-wage job.
- A low-income wage can make it difficult to save.
- Emergency funds should be used to finance actual emergencies, such as periods of unemployment or sudden medical challenges.
What Is an Emergency Fund?
An emergency fund is essentially money that’s been set aside to cover life’s unexpected events. The money will allow you to live for a few months should you happen to lose your job or pay for something unexpected that comes up without going into debt.
Think of it as an insurance policy. Rather than paying premiums to a company, you’re paying yourself money that you can use at a later date. The cash can be accessed quickly and easily if some unfortunate event happens to occur.
The COVID-19 pandemic increased a need for an emergency fund. An April 2021 Forbes survey conducted by YouGov found that the pandemic triggered nearly 40% of people who had emergency funds to access them, with 73.3% using up half or more of the fund and 29% all of it.
When the whole country suddenly went into virtual lockdown, many people lost their jobs and their income. What didn’t stop were their living expenses. The government did step in to help, but that took time and not everyone qualified for it.
How did the pandemic change the pre-pandemic statistics mentioned above? Bankrate released another survey when the pandemic was six months old and discovered that 35% of Americans said that their emergency savings were lower than before, with only 13% reporting an increase. Overall, only 16% of Americans said they were “very comfortable” with their emergency funds.
The latest Bankrate survey, released on July 21, 2021, found that 51% of Americans have less than three months’ of expenses covered in their emergency fund, including 25% who don’t even have a fund. Just 17% have more money stashed away than before the pandemic, while 34% have less. As for being “comfortable” with their emergency savings, 48% were not.
It makes sense to track how costs went during this pandemic and factor that into how much could be needed going forward. This is probably not the last one. Indeed, the Center for Global Development puts the chances of pandemic at 22% to 28% in the next 10 years, and 47% to 57% in the next 25 years. And plenty of less dire things can happen that create a demand for emergency funds, from a broken car to a broken arm.
So how much cash, exactly, should an emergency fund contain?
Determining an Amount
Many banks and financial experts suggest that you should save at least three months’ worth of salary in your emergency fund. That way if you do lose a job, you’ll have enough money to get by for a few months until you can find replacement work. However, depending on your preferences and income level, the amount can vary.
Start by calculating your living expenses. Tally up how much you spend each month on mortgage or rent, utility bills, groceries, and vehicle expenses. You should have at least enough to cover your living expenses for three months, and probably even more, say up to six months.
If you’re in a double-income household and are unlikely to find both income earners unemployed at one time, you may be able to rely on the assistance of a financially stable family member. If you have insurance policies that will cover you for unexpected emergencies, you may be able to get by with the bare minimum. However, everyone should make a point of setting aside at least something for unforeseen expenses.
Sticking to Your Goals
Setting a plan and sticking to it is the surest way to achieve most goals. Open an account that can’t be accessed with your debit card, such as an online-only eSavings account. Automate transfers to this designated account from your primary bank account to match up with your paydays, so that you won’t even see the money in your primary account.
Once you have a large enough sum saved in this liquid account, you can transfer some money to short-term bonds or a high-yield savings account, from where you can still access it fairly easily in times of need.
Knowing When to Use It
There may be times when it will be tempting to use the money toward taking a vacation, paying off significant debts, putting a down payment on a new home, funding a lavish wedding, or any other significant expense that arises. That’s why you should always create a list of acceptable expenses for your fund. Ensure that they are actual emergencies—things such as your living costs during periods of unemployment, sudden medical problems, repairs to your home because of a natural disaster or fire (or serious furnace-type breakdown), unanticipated veterinarian bills, unforeseen vehicle repairs, or surprise tax bills.
The whole point of an emergency fund is to prevent you from having to add to your debt in times of need or to scramble to wrangle money at the last minute. You want to be able to focus on the crisis, not raising money to cover it.
Saving vs. Paying Down Debt
There is much debate on which approach should be prioritized: paying down debt or building up your emergency savings. There are pros and cons to each. Paying down high-interest debt should always be your first priority because paying that interest is a substantial burden, but that doesn’t mean you shouldn’t be setting some money aside every month as well.
Striking a balance is the best approach. This helps to build good money habits and will prevent you from having to borrow funds if an emergency does arise. If you are paying off debt, consider how much you can reasonably afford to contribute to your emergency fund while doing so. Even if it’s only $25, this is the beginning of a good financial habit. Your fund will continue to grow, if only slowly, as your debt load diminishes.
The Bottom Line
Although it can be challenging to live below your means, you’ll be happy that you did when that rainy day arrives and the overall impact on your financial well-being is minimal. Focus on changing your mindset. The only person you can really depend on to get you out of trouble is you. Don’t rely on family, friends, government safety nets, insurance policies, or just plain luck. Bad things can happen to anyone, and working toward financial health should be just as much a priority as looking after your physical health.
What Is an Emergency Fund?
An emergency fund is a savings account containing money to be used only in the event of an emergency, such as losing your job, being faced with a sudden medical condition, or having to make an unexpected car repair.
How Much Money Should You Keep in Your Emergency Fund?
Financial experts advise keeping between three and six months’ worth of living expenses in your account.
Should I Pay Off Debt Before Saving in an Emergency Fund?
There are pros and cons to this. If you are paying off high-interest debt, that generally should come first, because it is such a financial hardship. That said, it’s good practice to build the sound financial habit of paying even a little toward an emergency fund while reducing high-interest debt.