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Life is full of surprises. Some are good, and some are downright unpleasant.
Unexpected expenses tend to be one of those unwelcome surprises. No matter how hard you might try to avoid them, financial emergencies can happen to anyone. After all, you can’t really anticipate or plan for everything that life might throw your way.
This is why everyone should have an emergency fund – a cash reserve that can help provide a critical safety net (and peace of mind) whenever life takes an unexpected turn.
Look, no one likes to be caught off guard. As it is in sports, the best defense is a good offense: Proactively building a strong emergency fund can help you tackle any unexpected challenges that might get in the way of you reaching your financial goals.
Hey, things break down. Financial emergencies can include things like major car or home repairs. Then there are also more serious events such as a medical emergency or losing a job. Both of these things could bring financial setbacks that might take some time to recover from.
Sometimes it’s hard to talk about emergency funds without sounding like you’re just out there spreading doom and gloom. But it doesn’t have to be a pessimistic discussion. As with many things in life, it’s all about perspective.
So let’s think about it this way: Emergencies happen. While you can’t control what unfolds, you can control how to financially prepare yourself for unwelcome events. An emergency fund essentially allows you some control over an ostensibly uncontrollable situation. And that’s powerful!
The size of the cash reserve you need depends on your financial situation (e.g., budget, employment, family size, etc.). Many financial experts recommend having enough to cover three to six months of living expenses – at least. If you can save more, you should.
Figuring out how much you need in an emergency fund starts by understanding how much you spend on essential living expenses. Think about that rent or mortgage payment, existing loan payments, average utilities, average grocery bills, and any other necessary expenses each month.
In addition to your budget, you’ll also want to think about your job – in particular, how you earn income. Someone who is self-employed or works on commission may need to consider building an emergency fund that can cover more than six months of living expenses in case work slows down for a while.
On the other hand, someone who is in a stable job with professional skills that are in high demand (in other words, can easily find another job) may not necessarily have to save more than six months of expenses, especially if their income is more predictable and they have a greater sense of job security.
Whether you need a larger or smaller cash reserve, don’t worry: Building a sizeable cash reserve can be accomplished through patience, discipline and consistency.
If you’re just starting out, know that every little bit helps when you're trying to reach any kind of savings goal.
To start, see if there’s any wiggle room in your budget. Even cutting back $25 a month is better than nothing. If you need help identifying areas in your budget to trim, consider getting an assist from a budgeting app to analyze your spending. Are there discretionary expenses that you could cut back or do without? Some apps can even help you cancel unwanted subscription accounts. The extra money you save from trimming your budget can be reallocated toward your emergency fund.
For those who have already started to put some money away but want to do more, in addition to revisiting your budget, there are a few things you could do to prioritize your emergency fund savings. Think about scheduling automatic transfers to your savings account every time you get paid. Setting aside your tax refund or bonuses from work could also give your savings a boost.
It’s a good idea to keep it separate from your regular savings or checking accounts because you don't want to mix up the money you regularly use with funds you need for your safety net. Having a dedicated savings account for your emergency fund can also help you easily track your progress towards your savings goal.
Keeping your emergency fund in a savings account or high-yield savings account can be a great option, as you would be able to earn interest and still have access to your money when you need it. If you already have some money set aside, you may also want to look into a no-penalty CD (NPCD) account where you could earn a competitive rate and have the flexibility to withdraw your funds without a CD early withdrawal penalty. Just remember that with NPCDs, once you open an account and make a deposit, you can’t continuously add money to it.
Keep in mind that an emergency fund is really intended for unexpected expenses. So here’s the question you must ask yourself first before reaching for the money that’s in the account: Is this a real emergency?
Everyone’s definition can vary. This is why you might want to consider setting up some ground rules for when you’re allowed to access your funds. For example, if you’re in a situation that requires you to act immediately, it’s probably an emergency. This might mean an urgent medical procedure or a loss of income.
Avoid using your emergency fund for predictable events or recurring payments because these things should already be a part of your budget – you shouldn’t have to dip into your emergency fund to cover them.
We know that all this might be easier said than done. To be sure, building up a cash reserve takes time, patience and discipline. But it can be done!
It’s well worth the effort, too: Your future self will thank you for your foresight and preparation when you’re able to lean on your cash reserve in times of financial uncertainty.
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 The Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.