Emergency Fund: What It Is And How To Build One

Every month you diligently pay off your credit card bills, student loans, and make sure to get that rent check in the mail on time. And that’s wonderful, but, is it enough?

If you’ve got nothing saved for an emergency, the answer is no, it’s not. Millions of Americans are living on the edge when it comes to emergency finances. A broken bone here, a leaking roof there, and a car exhaust system that just gave out is enough to send some people into financial ruin. Here’s how to ensure you’re not one of them.

Are You Among the Millions Who Can’t Cover an Emergency Expense?

According to the latest report from the FINRA Investor Education Foundation in 2016, 38 percent of Americans spent almost equal to their income and 18 percent spend more than their income. That means they are making it through the month, but hardly.

What’s more, a 2017 report released by the U.S. Federal Reserve found that only 59 percent of families could easily cover a $400 unexpected expense without having to sell their belongings or borrow money from their family or friends.

"Figuring out how much you need in an emergency fund starts by understanding how much you spend on a regular basis."

This lack of emergency savings is leaving people wide open for financial trouble. That’s why an emergency fund is not only necessary, but crucial for good financial health.

How Much You Should Have in an Emergency Fund

Conventional wisdom says you should have three to six months’ worth of expenses set aside for your emergency fund, but this really depends on your situation. You might need more, or you might need less.

Figuring out how much you need in an emergency fund starts by understanding how much you spend on a regular basis.

To be clear, we’re talking about the essentials — not all the extra nice-to-have expenses. Think about that rent or mortgage payment, existing loan payments, average utilities, average grocery bills, and any other necessary expenses each month. In an emergency all those extras like gym memberships, streaming movie accounts, and the beer of the month club should go.

You’ll also want to consider how you earn income. A freelancer or someone who works on commission may need to consider having more than six months’ worth of expenses in case work dries up or is slow for several months in a row. Someone with a job in a highly desirable profession (aka can easily find another job) may not need as much, especially if their expenses are much lower than their salary.

A simple way to calculate what you might need is working out your bare bones budget plus any anticipated expenses, like replacing your HVAC or a car tune-up.

If you need less, that’s great. Saving for it may not seem so intimidating.

If it’s more, don’t freak out. Building a sizeable emergency fund isn’t as impossible as it sounds.

How to Build an Emergency Fund

Every little bit helps.

To start, see if there’s any wiggle room in your budget. Even cutting back $25 a month is better than nothing. Apps like Clarity Money can help you analyze your spending and help you cancel unwanted subscription accounts. All those extra funds can be reallocated toward your emergency fund.

There are also other simple ways to create an emergency fund, like setting up automatic transfers every time you get paid, setting aside your tax refund or bonuses from work. If setting aside extra money for an emergency savings plan seems too daunting based on your current financial situation it may be time to think about getting a side hustle, like driving for a ride-sharing company or getting paid to complete tasks through freelance work until you have just a little put away for a rainy day. 

"A well-stocked emergency fund can be the difference between going into debt, or being able to forget the whole thing ever happened."

Where to Keep an Emergency Fund

Your best bet when it comes to housing your emergency fund is to keep it separate from your regular savings or checking account. The idea is that you shouldn’t allow it to get mixed up with the funds you use regularly, but it should still be readily accessible if you need it.

A high-yield savings can be a great option as you’ll earn interest and be able to access your cash if you’re in a pinch.  Many offer competitive rates and don’t have minimum balance requirements.

A no-penalty CD is another option because you could earn a higher interest rate than a savings or money market account. Unlike other types of CDs, you won’t be faced with an early withdrawal penalty after a certain period. But, with all financial products you open, check the fine print so you understand what you’re getting into.

Having an unexpected event that eats into your finances can stink. That’s why it’s crucial you save in case something does happen. A well-stocked emergency fund can be the difference between going into debt, or being able to forget the whole thing ever happened. 

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This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.