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May 21, 2024

Securing your future: The essentials of an emergency fund

By Team Stash
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life raft bouy in choppy water

In the unpredictable world of personal finance, having an emergency fund is like having a strong fortress that protects your financial health from unexpected problems. It’s very important, but not everyone understands its value. Having emergency savings is crucial during tough financial times. It’s a game-changer for everyone, from new graduates to established professionals.

What is an emergency fund?

At its core, an emergency fund is your personalized financial safety net—a dedicated reserve of cash established specifically to buffer unforeseen expenditures or financial emergencies. It’s not money from your regular savings set aside for vacation splurges or the latest must-have item; rather, it’s your insurance against the unpredictable twists life might throw at you.

Some examples of a financial emergency include:

  • Major medical bills
  • Job loss or sudden change in employment
  • Necessary home repairs (i.e. plumbing, heating/cooling, roof)
  • Car breakdowns or necessary repairs

The characteristics of a reliable emergency fund

What sets apart an emergency fund from your regular savings?

  • Accessibility: An emergency fund should be liquid, allowing quick and penalty-free access.
  • Reliability: Often involves having a separate account specifically for emergencies.
  • Preservation: Ensures the fund is not used for non-urgent matters.
  • Stability: The goal is to maintain a steady and, over time, substantial balance to cover genuine financial concerns.

What sets apart an emergency fund from your regular savings? Accessibility, for one. An ideal emergency fund is liquid, meaning you can access it quickly and without penalty. It should also be reliable, which often translates to having a separate account earmarked for emergencies. This ensures that you’re not tempted to dip into it for non-urgent matters, preserving its primary function. While the fund’s exact balance may fluctuate, the goal is to keep it steady and, with time, substantial enough to assuage genuine financial worries.

Differing from regular savings

Emergency funds are about specificity and intent. They’re not for the hoped-for events like vacations or the purchase of new shoes; they’re for the peace of mind in the face of necessary but unexpected financial drags. In contrast, regular savings are planned, budgeted out, and have a specific end goal, such as that house down payment or a child’s college education.

The importance of having an emergency fund

A shield against the unknown

An emergency fund’s primary job is to act as an impromptu shield, giving you the financial power to combat unexpected medical bills, car repairs, or even the dreaded job loss. In these moments, the fund steps in where regular income and savings might fall short, providing the crucial stability required to weather the storm.

De-stress your finances

Perhaps less referenced but equally vital, an emergency fund can help alleviate the stress that unexpected finances bring. With life’s financial uncertainties preemptively accounted for, you can sleep a little easier knowing you’re prepared for the unknowns.

Avoid deep debt

Saving money for worse case scenarios can help you avoid going into debt. Without money set aside an unexpected expense, you can be left with very few options other than borrowing. Relying on a credit card or even personal loans during a crisis can worsen your financial problems. When borrowing, you’ll always have to pay it back and usually with interest on top of it. 

How much emergency fund should I have?

The 3-6 month conundrum

Advisors often prescribe an emergency savings fund capable of covering three to six months’ worth of living expenses. Why this range? It’s a balance—enough to address most emergencies without being overly burdensome to save for your average household.

Personalizing the approach

But we’re not all cut from the same financial cloth. Personal responsibility means assessing your unique situation. Multiple variables like job security, familial status, and even your own comfort level play into this calculus. The key is to save diligently, progressively hitting milestones, even if you can’t establish the full six-month reserve immediately.

Ways to build your emergency savings

Building an emergency fund is a feat of financial persistence. Start with small, manageable contributions, gradually increasing them as your means allow. Automating your savings is a way to ensure consistent growth, as is refining your monthly budget to reveal hidden pockets of potential contributions.

Where to keep your emergency fund

Where should you keep your savings? You have a few choices like regular savings accounts, money market accounts, and high yield savings accounts. Each has different benefits and limits, fitting different money situations.

Weighing the options

Savings accounts offer the greatest liquidity but typically lower interest rates. Money market accounts hybridize, providing a balance of liquidity and better returns. High yield savings accounts can offer you a higher interest rate, but access to your money may not be as immediate as your traditional savings account. Balancing these factors against your needs—thinking in terms of what you could sacrifice in terms of accessibility for better growth—will yield the best results.

Balancing these factors against your needs—considering what you could sacrifice in terms of accessibility for better growth—will yield the best results.

Personal preference matters

Your comfort with risk affects how you manage your money. If you prefer playing it safe, you might choose a savings account at a local credit union. But if you’re okay with some risk for higher returns, you might go for staggered CDs, even if it means a penalty for taking your money out early.

When should you use your emergency fund

What exactly warrants the use of your emergency savings? Defined by unanticipated, essential outlays, emergencies range from leaky roofs to life’s larger, more impactful disruptions. It’s not for that impromptu trip of a lifetime; it’s for the unexpected medical bill that becomes paramount.

Listing out true emergencies

Discernment is key. Keep a list of what emergencies, in your specific life, would merit emergency fund intervention. Think major, necessary, and sudden. Birthdays, while important, aren’t an emergency – they just require planning. Is your landlord suddenly doubling your rent with a month’s notice? That’s an emergency in the making.

Here are some emergency expense examples of where your emergency cash would come into play:

  • Major medical bills
  • Job loss or sudden change in employment
  • Necessary home repairs (i.e. plumbing, heating/cooling, roof)
  • Car breakdowns or necessary repairs
  • Natural disasters (e.g. storm damage to house)
  • Unexpected travel expenses for family emergencies
  • Loss of a significant source of income (i.e. spouse’s job)
  • Legal fees for unforeseen circumstances (e.g. custody battle)

There are many more emergencies and unexpected events, but you’ll likely know when to withdraw money from it if or when the time comes. The key is to use your emergency fund only for unexpected, essential expenses that you cannot cover with regular income or savings at the time of the event.

Using your emergency fund effectively

Using your emergency fund should be a careful choice, not a quick reaction. Make sure you really need to spend the money and always put essentials first, especially if the emergency lasts a long time. After you use it, plan how to put money back into your fund. It takes time, knowledge, and planning to build a good emergency fund. It’s not exciting, but it’s crucial for handling unexpected money problems without stressing too much.

Think of your emergency fund as a way to stay in control financially in a world where things can change quickly. Start with whatever you can, but the important thing is to start. Being prepared and thinking ahead are key to managing your money well.  Keep educating yourself and be prepared for whatever life throws your way. Remember, having an emergency fund is not just a financial strategy, it’s a peace of mind strategy.

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Written by

Team Stash


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