How big should your emergency fund be?
It would be great if everyone had an unlimited amount of money to spend. But that's just not how life works, which is why it's important to have an emergency fund.
An emergency fund is money that you set aside to cover unexpected expenses. It shouldn't be used to cover your regular bills or buy that killer new video game on release day. Emergency funds are there to cover true emergencies.
Keep reading to learn why an emergency fund is so important, find out how using an emergency fund calculator can help you get clear on your goals, and get tips for building an emergency fund of your own.
Why you should have an emergency fund
No matter how much money you earn and how wisely you spend it, you're going to encounter a financial emergency at some point. Maybe your car breaks down on the way to work or your furnace stops working on one of the coldest days of the year. When you have an emergency fund, these events are annoyances instead of complete catastrophes.
Grow your savings
An emergency fund also makes it easier to grow your savings. If you keep the money in an account that earns interest, you'll make a little extra money without any extra effort. Just don't use your emergency fund to buy stocks or other risky investments—you don't want to lose your hard-earned money if the market dips.
If your car broke down right now, how would you pay for the repair? Without an emergency fund, you'd probably use your credit card or apply for some type of financing. If you always use credit to cover emergency expenses, it's harder to keep your debt balance low.
With an emergency fund, there's no need to swipe a credit card or apply for a loan. You can pay for unexpected car repairs, emergency medical bills, and other surprise expenses with the money in your account.
Build a rewarding career
When you don't have any savings, it's difficult to build a career that really works for you. Even if you don't love your job, you may have to keep plugging away at it just for the paycheck and benefits. An emergency fund can provide you with more freedom to make career decisions that make you happy.
Having an emergency fund also makes it easier to deal with layoffs, pay cuts, and other work-related problems. If you get laid off without an emergency fund, you might take the first job that comes along, even if it's not really what you want to do. You may even ignore some red flags about the job or the employer just to avoid a financial mishap.
An emergency fund helps you avoid making hasty decisions. Instead of taking the first job you find, you can spend time looking for a job that truly suits your skills and interests. You may even be able to take a class or get a certification that helps you make even more money when you go back to work.
If you have a bit of entrepreneurial spirit, having an emergency fund can even help you get your business off the ground. It's tough to work all day and then try to work on your business in the evening or on weekends. If your emergency fund is big enough, you may be able to work fewer hours or focus on your own business entirely.
Where to keep emergency fund money
The point of having an emergency fund is to be able to access money in an emergency. So, don't use the money to buy stocks or keep it in an account that takes days to access. Think of an emergency fund as a safety net rather than an investing tool.
One of the best places to keep emergency money is in your checking account. If you have an emergency, you'll be able to use your debit card or write a check to cover it.
If you worry about spending part of your emergency fund by mistake, it may be a good idea to open up a savings account. The easiest option is to use the same bank for checking and savings. If you do, you'll be able to transfer money between accounts, making it even easier to save for emergencies.
Money market account
A third option is to use a money market account. This is a bank account that combines the benefits of a checking account and a savings account in one place. When you deposit money, you earn a bit of interest, making it easier to grow your emergency fund balance.
How much money to keep in an emergency fund
"How much should I have saved by 25?" "How much money should you save each month?" These are common questions about how to increase financial stability.
Although it's helpful to set some financial goals based on your age range, there's a better way to figure out how much money to keep in an emergency fund. Instead of focusing on age, focus on your monthly expenses.
Think about two of the most important people in your life. There's a good chance that one of them makes more money or has more expenses than the other one. Even if they're the same age, they need to save different amounts of money for emergencies.
To figure out how much to save, first you need to add up your monthly expenses. In addition to rent or mortgage payments, utilities, groceries, and health care expenses, don't forget to include all the little things that really add up over time.
Credit card payments
Public transportation fees
Generally, you should save about 3 to 6 months' worth of expenses in an emergency fund. If your monthly expenses add up to $2,500, you'll need to save $7,500 to $15,000.
If you're starting with $0 in savings, don't panic. Even if you can't save $7,500 right away, it's better to have some emergency savings than none at all. As little as $500 can help you cover emergency expenses without taking on more debt.
Using an emergency fund calculator
To get a better idea of how much you should save, use an online emergency fund calculator to enter your information and receive customized recommendations. These calculators ask questions about your expenses to determine exactly how much you should save.
An emergency fund calculator can also help you identify expenses to reduce or cut out completely. If you have four streaming subscriptions and only use two of them regularly, you may be able to cancel without penalty. Then, you won't have to save quite as much money in your emergency fund.
How to build an emergency fund
Once you know how much to save, you need to know how to save it. If you're already on a budget and have no extra expenses to cut, consider meeting with a financial counselor. You may qualify for debt relief or some other type of financial assistance.
If you haven't tried budgeting yet, it's a good place to start. For many people, the word "budget" conjures up images of sitting at home and never spending any money. That couldn't be further from the truth.
A budget is simply a tool to help you understand how much money you have coming in and how much is going out. Budgeting carefully can help you avoid wasting money, making it easier to build up your emergency fund.
To create a strong budget, you need to know how much you make and how much you spend each month. Income includes money from the following sources:
Salary/wages from a job
Payments for goods sold on eBay, Poshmark, and other online resale sites
Payments for freelance services (e.g. graphic design, copywriting, web design)
Don't worry if you only have one or two sources of income. Not everyone owns a rental property or has valuable goods to sell via online marketplaces.
Because you had to add up your expenses to figure out how much money to save, you already know how much you spend each month. If you need to run the numbers again, be sure to include every single thing you spend money on. That includes manicures, pedicures, coffee runs, gym fees, and subscriptions.
Now subtract your total monthly expenses from your total monthly income. If there's money left over, great! You'll be able to use that money to build up your emergency fund.
If you get a negative number, look for ways to reduce your expenses. Can you switch to a cheaper gym or cancel one of your subscription services? If so, make those changes ASAP.
Another good way to reduce your expenses is to negotiate with creditors and shop around for better rates on your insurance. One of your credit card companies may be willing to lower your monthly payment or interest rate, leaving you with more money available for savings.
Now, it's time to start saving. One of the easiest ways to put aside money is to set up automatic transfers from your checking account to your savings account. Even if you can only transfer $15 per week, that's still $60 per month toward your emergency fund.
Saving money doesn't have to be boring—it can actually be fun. To get excited about saving, try a monthly savings challenge. You can do these challenges on your own or with friends to make them even more exciting.
If your New Year's resolution is to start an emergency fund, try the 52-week savings challenge. The goal is to save $1 the first week, $2 the second, $3 the third...all the way up to $52 during the 52nd week of the year. If you save the correct amount each week, you'll have $1,378 by the end of the challenge.
Another fun way to save money is to create your own savings challenge worksheets. You don't need pro design skills, just a word processing program and a piece of clip art.
The first step is to figure out how much you want to save. Then, you need to choose a graphic to color in every time you get a little closer to your goal. Try using a thermometer as a visual representation of your progress.
Finally, print out the worksheet and hang it on your fridge. Every time you get 10% closer to your goal, color in 10% of the thermometer.
If you've cut all your expenses to the bone and still have a tough time saving money, increasing your income can help. Not everyone has the energy for two jobs, but there are ways to earn money by working just a few extra hours per week.
Think about your skills and experience. Is there anything you can do to make someone's life easier? Help a business earn more money?
If so, consider offering your services. These are just a few ways to make money in your free time:
Provide lawn care services
Do small home repair jobs
Sell your designs on Etsy
Write blog posts and other types of content
Teach adult enrichment courses (e.g. knitting, creative writing)
The bottom line
An emergency fund can save you a lot of financial headaches over the years. Here's what you need to remember as you start saving:
You should aim for 3 to 6 months' worth of expenses.
Don't worry if you can't save a ton right away. Some money is better than no money.
Automatic savings transfers and savings challenges can help you get into the habit of saving.
Doing a side hustle can help you earn extra money, making it easier to build your emergency fund.
Plan ahead by exploring the Varo Savings Account and all it offers.
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