How Do I Build an Emergency Fund?
How do I build an emergency fund? Learn how to better prepare for unexpected expenses by building an emergency fund before you need it. [Duration- 2:12]
Reading time: 3 minutes
Almost 60 percent of Americans don’t have enough money in their savings account to pay for an unexpected $1,000 expense, according to recent data from Bankrate.com. So, it’s not surprising that sudden emergency expenses — be they as mundane as car trouble or as extraordinary as a global pandemic — are one of the main reasons people go into debt. While you can’t always know what life has in store, you can prepare for the unexpected by building up an emergency fund.
An emergency fund is money that you set aside to cover unanticipated costs but that’s kept separate from your long-term savings (such as retirement accounts or any home-buying savings you may have).
Most financial advisors suggest that you set aside enough money to cover six months’ worth of living expenses. If you lose your job and are forced to tap this fund, you’ll probably choose to cut costs to make your emergency fund last as long as possible. However, by building your safety net based on the full amount of your monthly take-home pay, you’ll leave yourself a little wiggle room for unexpected expenses that may pop up while you’re searching for a job.
A good rule of thumb is to save 10 percent of your net income. If that percentage seems impossible in light of your monthly expenses, try setting aside 5 percent to start and increase that amount by 1 percent each month until you’ve reached the 10 percent threshold.
Once you start growing your emergency fund, it can be difficult to ignore the money that’s sitting in your bank account. To avoid the overwhelming urge to spend your savings prematurely, it’s important to set some clear rules for yourself regarding when you will use your emergency money.
There are a few situations that usually constitute a financial emergency, including:
- Job loss
- Medical emergencies (including those that affect your pets)
- Auto repairs (particularly when your car is your primary mode of transportation)
- Urgent home expenses (such as a leaking roof or flooding basement)
If you have an expense that doesn’t fit neatly into one of these categories, consider asking yourself the following questions:
- Is it truly an unexpected expense? You may feel like your spouse’s birthday sneaks up on you every year, but you should budget for gifts in advance instead of taking cash out of your emergency fund.
- Is it an absolutely necessary expense? Repainting your house because you’re sick of the color doesn’t count as a necessary expense, but fixing the leaking gutters does.
- Does the expense cover an urgent need? Typically, if it’s something that can wait, such as a new couch, you should save for the expense instead of pulling from your emergency fund. However, knee pain that requires surgery is an expense that could come from your emergency savings.
Finally, if you do find yourself tapping your emergency fund to cover an urgent, unexpected expense, be sure to repay what you borrowed when you’re back to financial stability. Your emergency fund won’t do you any good if it’s empty when the next rainy day rolls around.