How to Build an Emergency Fund

How to Build an Emergency Fund Aug 26, 2022 5:30:00 AM An emergency fund keeps you afloat when your regular income can’t. Learn how to start one and grow it. In 10 seconds An emergency fund keeps you afloat when your regular income can’t. Try saving at least three months’ worth of expenses, so your finances can handle a sudden job loss or medical emergency. In 1 minute An emergency fund helps protect you from the most common financial crises. It helps cover unexpected expenses that don’t fit into your regular budget, and buys time to find a new job or manage a transition. For most people, the goal is to have enough funds set aside to pay for at least three months of living expenses, including food, housing, and other essential costs. But exactly how much you need depends on your situation. If you have more dependents or greater risks, you may need more than that to feel comfortable. Ideally, you should automate deposits into your emergency fund to make sure it grows each month until it reaches an appropriate size. You may also want to put this money into a cash account or low-risk investment account to help it grow faster, as long as you are ok with taking on this risk. Betterment makes both of these options easy, and with recurring deposits, you can make steady progress toward your goal. In 5 minutes In this guide we’ll cover: Why you should build an emergency fund How much you should save How to grow your emergency fund You can’t anticipate every financial disaster. But with an emergency fund, you can reduce their impact on your life. It’s a special account you don’t touch until you absolutely need to. If you’re like most people, this is one of your first and most important financial goals. Without an emergency fund, you could find yourself taking on high-interest debt to avoid losing your home. Or unable to meet basic needs, you may have to make hard choices about which necessities to live without.  So, how much should you save? What should you do with the money you set aside? And what counts as “an emergency”? Your emergency fund is personal. It needs to fit your life, your needs, and your risks. Some may only need a few thousand dollars. Others may need tens of thousands. It all depends on your regular expenses and how prepared you want to be. How large should your emergency fund be? For most people, the goal is to have enough to cover at least three months of expenses. That’s rent or mortgage, utilities, food, and anything else you pay every month. If you unexpectedly lost your job or had a medical crisis, your emergency fund should be enough to help you through most transitions.  Some folks should save more. If you’re a single parent or the only person with income in your household, a sudden loss of income would have a greater impact. If you work in an industry with high turnover, or you have a serious medical condition, you’re more likely to need these funds, so you may want to save more, such as six months of your monthly expenses. It may help to think of your emergency fund as time. This isn’t just a target dollar amount. It’s months of time. How long would you like to keep the bills paid without a job? How much would it take to do that? That’s the amount you should save. There’s no magic number that’s right for every person. And since it’s based on your current cost of living, the amount you’ll want to save will change with your expenses. Live more frugally, and you may be more comfortable with a smaller emergency fund. Get a bigger house or apartment, add a family member, or spend more on basic needs, and you’ll need a bigger emergency fund. How to build an emergency fund The hardest part of building an emergency fund is figuring out how saving fits into your life. It helps to work backward from your goal. Once you know how much you need to save, decide when you want to save it by. The sooner the better, but choose a timeline that makes sense for you. Then break your goal into chunks—how much do you need to save each month or each paycheck to get there on time? The last part is easy. Make your savings automatic with recurring deposits. You make the commitment once, then see steady progress toward your goal. You don’t have to think about it anymore. Set up a Safety Net goal with Betterment, and we’ll take care of this for you. Set how much you want to save and when you want to save it by, then decide how much you can put toward that goal each month. Create a recurring deposit, and you’ll start saving automatically. This video sums it all up. Where should you put your emergency fund? A lot of people put their emergency fund in a savings account at a bank. It keeps their money liquid, and it’s federally insured by the FDIC. So there’s little risk of losing what you’ve saved. Obviously, you want your emergency fund to be there when you need it, so it’s understandable why so many people are drawn to savings accounts. But it may not be the best way to grow your fund, either. Most savings accounts generate so little interest that they’re basically cash. It’s a step above putting money under your mattress. And like cash, savings accounts will usually lose value over time due to inflation. Thankfully, you have options. You can generate more interest without taking on much more risk. Here are some alternative places to put your emergency fund. High Yield Cash Account Like a regular savings account, most cash accounts are federally insured. But unlike a traditional savings account, these can generate meaningful interest. A high yield account takes your money further, and it’s still highly liquid. Certificate of Deposit (CD) A certificate of deposit, or CD, is basically a short-term investment. It lasts for a fixed duration, such as 12 months or 5 years. At the end of this period, the CD “matures,” and you typically earn more interest than you would with a high yield cash account. CDs are federally insured and still low-risk, but until your CD matures, it’s not liquid unless you pay a penalty to get out of the CD early. This makes it a little riskier for an emergency fund, since you never know when you’ll find yourself in a crisis. Low-Risk Investment Account Investment accounts can offer greater growth potential in exchange for taking on more risk. While stocks are considered volatile because they frequently change in value, bonds are generally more stable. An investment portfolio consisting of all bonds can still outpace a CD, a high yield account, and inflation, while putting your emergency fund at significantly less risk when compared to a portfolio consisting entirely of stocks. If you feel investing is the right move for you, Betterment recommends giving yourself a bigger buffer, adding 30% to your target amount. That way your money can grow faster, but it’s also protected against potential losses.