How to build and use an emergency fund
In weather and in life, rainy days are inevitable. From natural disasters and economic hardship to car repairs and medical bills, the unexpected happens, and it can be expensive. Insurance coverage, support networks and government aid are important safety nets, but they aren’t always enough. That’s why experts recommend maintaining an emergency fund to prepare for a rainy day.
Why you need an emergency fund
An emergency fund is money you set aside to help cover unexpected financial emergencies such as loss of income or major expenses. These emergencies may include unemployment, medical bills, home or vehicle repairs and more. A good emergency fund can provide three important benefits during a financial emergency:
- Helping to cover crucial expenses such as health care, housing, transportation and basic necessities (example: paying to fix an essential vehicle that needs an expensive repair)
- Avoiding the need to incur secondary expenses such as fees, interest, tax penalties and opportunity costs (example: not having to borrow money or dip into retirement savings during a period of unemployment)
- Reducing stress and anxiety relating to a financial emergency (example: not worrying how to pay for a trip to the emergency room)
When to start building your fund
If you can afford to set some money aside, you’re probably ready to establish an emergency fund. Don’t worry about your fund just yet if you’re currently in the middle of a financial emergency, if you have high-interest debt (e.g. credit card balances) or if you’re struggling to pay bills. Those urgent priorities should typically be resolved first before you look to the future and start building your emergency fund.
How much to keep in your fund
One of the toughest decisions to make for your emergency fund is how much money to keep in it. Many experts recommend setting aside three to six months’ worth of expenses. Since the future is unknown, it’s impossible to know which exact amount is right for your fund, but your personal situation will determine whether you should lean toward a larger or smaller amount.
Here are some important factors to consider when deciding on the size of your fund:
- Size of financial safety nets (insurance coverage, family assistance, etc.)
- Number of dependents (individuals requiring financial support)
- Level of job and income stability
- Amount of property and liabilities (homes, vehicles, etc.)
Where to keep your fund
It’s critical that your emergency fund balance be safe and quickly accessible. That means keeping it away from risk such as the stock market and keeping it in a liquid form such as a bank account. An FDIC-insured checking or savings account generally provides the best protection and access to your money. If you’d prefer that your emergency fund earn a bit of interest, you can consider regionally and nationally available high-interest bank accounts.
When to use your fund
Your emergency fund can be used for any necessity that you can’t pay for without taking on high-interest debt (e.g. credit cards) or dipping into your long-term savings. When such an emergency arises, don’t be shy about utilizing your fund. That’s what it’s there for! Use the money where it’s needed, then build your fund back up once the hardship has passed. Resist the temptation to raid your emergency fund for unnecessary spending, and remember to include inevitable expenses such as home and vehicle maintenance in your regular budget.
Building an emergency fund isn’t always easy. It can take months or years of discipline to do so, and you may not see a dramatic benefit any day soon. However, you’ll gain important peace of mind in the meantime, and when a rainy day does come your way, you’ll be very glad you’ve prepared.
Draper and Kramer Mortgage Corp. does not provide financial planning or tax advice. This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for financial planning or tax advice. You should consult your own financial planning or tax advisers before engaging in any transaction.