Originally published 8/30/2016, updated on March 17, 2020
They happen all the time: those unanticipated expenses caused by illness… auto problems… job loss… appliance breakdowns… and the list goes on. Sure, they’re all part of life, but where’s the money supposed to come from to help pay for them? That’s where an emergency fund comes in handy.
Emergency funds are intended for use only when, well, “emergencies” occur. It’s a good idea to have enough in your fund to cover six months worth of expenses, including:
- Housing – mortgage, rent, property taxes, insurance, and utilities
- Food – know your monthly food expenses as you create the budget for your fund
- Healthcare – medical and dental insurance
- Auto – factor in a loan (if there is one), insurance, fuel, and potential repairs
- Miscellaneous – clothing, toiletries, cleaners, household supplies, haircuts, etc.
Review your monthly bills and receipts to get a good idea of how much you’re currently spending each month. That will allow you to set up a savings goal and figure out how to fill your fund with six months worth of expenses. (Use our myFICO Emergency Fund calculator to figure out your goal.)
How to fund the emergency fund
So now that you know why you need an emergency fund and the amount of money it should contain, how is the fund going to get filled?
- Automatically depositing a specific amount of your paycheck into the fund is a good way to start. It doesn’t need to be a huge amount… a little at a time adds up over time. You just want to reach the goal of having a minimum of six months’ of expenses available if the need arises.
- You can also take a look at your current budget. (Use our FICO calculator if you need some assistance.) Where can you cut back? What “luxuries” can you eliminate, at least until you’ve reached your emergency fund goal? A little sacrifice now can pay off big when you need the money to help you live through a difficult time.
- Lastly, think about things you do (or don’t do) that can be wasting money. Is your electric bill higher than it should be because you always leave the lights on? Do you purchase premium fuel instead of regular octane fuel when there’s no reason to do so? Are you paying higher interest on a loan or credit card than you should be? Do some calculating and then make some changes that can help you put more into your fund and reach your goal quicker.
Where to keep the emergency fund
Since emergency fund “accessibility” is a priority, people often find that deciding where to keep their fund becomes a dilemma. There’s also the issue of high risk versus low risk. With the high-risk placement of your fund (i.e. the stock market), you can increase its value faster if the market goes up. However, if the market goes down, you can lose value just as quickly. Of course, the risk of putting your fund into a savings account is very low, but so is the interest/rate of return. And then there are products like Certificates of Deposit and bonds that earn you higher interest and keep your money safe, but take longer to convert to cash (liquidity) and could cost you a penalty if withdrawn early.
So where is the best place to keep your money so that risk is low, liquidity is high and accessibility is fast? You might want to consider a money market account. These types of accounts can be opened with a bank or credit union and also have their pros and cons.
PROS – Higher interest rates than basic checking or savings accounts plus easier accessibility than a Certificate of Deposit or bond.
CONS – There’s usually a minimum balance required to open/maintain a money market account and a cap on withdrawals.
So before choosing a money market account, be sure to check the minimum amount required, withdrawal regulations, the amount of risk and potential fees.
When all is said and done, you want your emergency fund to have the money you need, when you need it while growing as much as possible. Hopefully, the only thing you’ll ever need the fund for is peace of mind.
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