Imagine your car breaks down driving to work. You get it towed to a shop, walk to work and the mechanic calls an hour later. “It’s your transmission. We’re looking at $2,000 with parts and labor.” What do you do?
If you had an emergency fund, you could pay most or all of the repair bill that day. And by having the money ready, you can avoid adding credit card debt, touching your retirement savings or asking family and friends for assistance.
To uncover the power of this lifesaving savings account, let’s dig into the basics:
What is an emergency fund?
An emergency fund is a stash of money you keep for financial surprises. The amount can vary per person, but the principle remains the same: for emergency use only. This way, when you’re hit with a stressful and unexpected expense, you know the money you need is ready and waiting.
Uses for an emergency fund
The reasons to dip into these funds can be personal, but the basics apply to almost everyone. Here are some common examples:
- Medical emergency – emergency room visits, sudden illness or surgery, dental work
- Family emergency – aging parents or family member needs immediate financial help
- Car repairs – engine repair, transmission repair, major accident damage
- Home repairs – leaking roof, flooded basement, major electrical repairs
- Job loss – unexpectedly getting laid off and having no other source of income
Where to save the money
The first thing to keep in mind is these funds need to be accessible at any time. While making interest on the money would be an added bonus, it’s not the main goal. A few options include a high yield savings account, money market account or a no-penalty certificate of deposit (CDs).
It might also be a good idea to keep your emergency fund at a bank separate from your main bank accounts. By not seeing the account every day, you may be less tempted to withdraw funds for non-emergencies.
How much you should save
Some financial experts recommend saving three to six months of living expenses. Others say more. When it comes to your emergency fund, it may come down to two things — what you might need it for and how much you can afford to deposit each week or month.
For example, if you’re single and don’t own a car, your situation is different from a family of six with two vehicles. Take a good look at what balance makes you feel the safest and make that your target.
Ways to save and build your fund
When starting an emergency fund, it can help to make your first deposit a large one; think tax refund or a bonus at work. By starting big, you might be more driven to keep the balance going up and up.
As for routine deposits, automatic deductions from your paycheck can add up quickly. Even if you only deduct $25 from your check each week, you'll save $1,000 in less than a year. For more ways to stuff your fund, check out our blogs on how to build an emergency fund and hobbies than can make you money.
There when you need it most
Emergencies can happen to anyone. To avoid the added stress of, “How am I going to pay for this?” start an emergency fund today. You’ll thank yourself when it counts.
*This article has been updated from its original posting on January, 2014.