How to Build an Emergency Fund: A Simple Guide for Beginners
How to build an emergency fund? Building this fund requires some simple steps, such as determining a savings target, opening a separate account, and setting up automatic savings.
Life doesn’t always go as planned. Broken cars, leaking roofs, and medical problems will cause you to incur unexpected expenses. Without an emergency fund, these expenses can cause financial difficulty. Therefore, beginners need to know how to build an emergency fund.
Many people find that building an emergency fund is challenging. Some people cannot reach their emergency savings target within a targeted timeframe because of various factors. Others have no savings for emergency expenses because they don’t know how to build this fund.
Understanding the Emergency Fund
An emergency fund is money you allocate for unexpected expenses. It provides a safety net during financial difficulty, so you can maintain your life without taking on debt.
You must save your emergency fund in an easily accessible bank account or liquid investment instruments. When you need this fund, you can access it easily.
1. When to Use an Emergency Fund?
People must use their emergency fund only for essential expenses during financial hardship. In most cases, this fund covers two types of financial emergencies.
- Income Shocks: A country’s economic conditions or other factors may cause people to lose income. The loss of income can cause significant financial difficulty. Therefore, you must use your emergency fund to avoid this hardship.
- Emergency Shocks: These are unplanned expenses caused by unexpected conditions. Emergency shocks include emergency home repairs, car repairs, and unexpected medical or vet bills.
2. How Much Emergency Savings do I need?
A financial emergency may take up most of your income and cause you to have difficulties meeting day-to-day essential expenses. However, if you have enough funds in your emergency savings, you won’t need to suffer during this financial setback.
According to experts, an ideal emergency fund ranges from 3 to 6 times your monthly living expenses. Therefore, if you currently spend $1,200 per month on living expenses, your emergency fund must be at least $3,600.
You may need to adjust your emergency fund amount when you start a family or when your family grows. Moreover, you must rebuild the fund if you spend parts of it on unexpected expenses.
How to Build an Emergency Fund
Building an emergency fund can be challenging for beginners. Bad saving habits, debt, low income, or overwhelming financial goals often hinder beginners from building this fund. Below are steps to build an emergency fund for beginners.
1. How to Start an Emergency Fund: Set Your Savings Goal
You cannot build emergency savings effectively if you don’t have an emergency savings goal. To calculate your savings target, you can assess your expenses to determine your total monthly spending.
You can build two emergency funds for different expenses. An emergency fund for spending shocks must be at least half of your monthly expenses. Meanwhile, emergency savings for income shocks must be at least three times your monthly expenses.
2. Monthly Saving
How to build an emergency fund? Building an emergency fund requires saving a specific amount of money every month. Therefore, you must decide how much you must save each month.
To determine this amount, create a monthly budget and allocate a specific amount of your income to emergency savings. Low income or debt may cause some people to have little money left to save.
However, saving $50 per month can help you build an emergency fund more successfully than saving a larger amount of money now and then. To save more, cut variable expenses, such as groceries and nonessential spending, or find a side job.
3. Open a Separate Bank Account
You must separate your emergency fund from your other money so you don’t accidentally spend it on daily expenses. Therefore, you must open a separate bank account or digital savings pocket for emergency savings.
4. Automate Savings
How to build an emergency fund effectively? Building this fund needs commitment. To help you make monthly contributions to this savings, set up automatic transfers from your main account to your emergency savings account or digital pocket.
5. Review Your Savings
You need to review your savings regularly to see how close you are to your emergency savings target. If you think your savings strategies do not give you effective progress, you can revise them so you can reach your savings goal more quickly.
Where to Keep an Emergency Fund
Building an emergency fund is not only about saving money every month. You must also consider the safety of the savings account you use for building the fund. You may also want to keep it in an account where it earns interest.
Below are three recommended accounts to build your emergency fund safely and profitably.
1. High-Yield Savings Account
Many people choose a high-yield savings account as a place to grow their emergency funds. This account offers safety and easy access. You can access your funds anytime, without waiting for the savings period to end. However, banks typically limit withdrawals or transfers.
This savings account type also lets emergency funds earn interest up to 4.25% APY. Therefore, your emergency fund will make significant progress if you keep it in this account.
2. Certificate of Deposit
A certificate of deposit is also a safe place to save your emergency fund. A CD offers higher interest than a high-yield savings account. The interest your fund earns from a CD can reach 5.20% APY, depending on the term. Unfortunately, it has lower accessibility.
You can only access your fund when the term ends. If you withdraw your deposit before the term ends, you must pay a penalty. Therefore, it is better not to put all your emergency funds in a certificate of deposit.
3. Money Market Account
Another safe place to keep your emergency fund is a money market account. It offers many benefits similar to a checking account and a savings account. This account gives profitable interest, up to 4.05% APY.
This account is also easy to access. Most banks offer this account along with a debit card and checkbook. These features allow you to access your funds anytime with few limitations.
How to build an emergency fund? Building this fund is not challenging if you set a savings goal and determine the amount of money to save each month. Some people may not be able to save a large amount of money each month, but it is okay as long as they make monthly contributions.