Building an emergency fund is a foundation of personal financial management.
This financial safety net ensures that unexpected expenses, such as medical bills or car repairs, do not strain your budget.
According to a 2024 survey by CNBC, 44% of Americans do not have enough savings to cover a $1,000 crisis.
You can create an emergency fund by making a target, making regular savings, keeping the money in a separate account, adjusting your expenses, and boosting your income.
I saved $20,000 in emergency funds just ensuring regular savings and automating most of them.
Calculate how much can you save?
Set your financial goal to determine the fund
Establishing the right financial goal is crucial to determining the amount you need to cover a crisis moment.
Financial experts recommend that saving three to six months’ worth of living expenses provides a cushion for most emergencies.
To determine the emergency fund, calculate your monthly expenses, including rent, utilities, groceries, transportation, and any other essentials. Multiply this figure by three to six to find your target amount.
For example, if your monthly expenses total $3,000, aim to save between $9,000 and $18,000 depending on your income and saving ability.
Set Up a Separate Savings Account
A dedicated savings account is crucial to ensure that emergency funds are always there to help.
This separation prevents the possibility to dip into your emergency savings for non-emergency expenses such as grocery, entertainment, and shopping.
Look for a high-yield savings account to earn interest on your balance while maintaining easy access to your funds. High-yield accounts such as BrioDirect, Ivy Bank, TAB Bank, and UFB secure savings can offer up to 5.30% APY.
Automate your savings
Automating your savings makes the process easier and more consistent. An automatic transfer instruction from your checking account to your emergency fund savings account ensures the fund is separated on time.
By this, you can ensure your emergency savings are isolated and you will get used to a revised budget since the amount for automatic transfer instruction will no longer be available for your usage.
Even small regular contributions can make a fund for you gradually. Think about isolating $50 per week to a separate account, you will accumulate $2,600 in a year.
Remember, building a fund with your low earnings requires constant financial attention.
Reduce Unnecessary Expenses
A reduction in unnecessary expenses acts like an additional income. If you can trim 50% of your luxury expenditures, you can easily gather that amount to your emergency savings account.
You can easily boost your emergency funds by dining out less frequently, canceling unused subscriptions, and shopping for deals.
According to the Bureau of Labor Statistics, the average American household spends about $3,000 per year on dining out.
If you can redirect even half of this average amount, you will save $1500 in a year without affecting your paychecks.
Increase your income
Increasing income helps significantly to save on the emergency fund account. Consider taking on a side job, freelancing, or selling unused items. Even temporary boosts in income can make a big difference.
For example, if you can earn $200 extra per month, it will help you reach your savings goal fast.
If you are skilled personnel, try side hustle websites such as Upwork and Fiverr which offer numerous opportunities to earn extra income through freelancing.
Use windfalls wisely
Windfalls are unexpected gains such as tax refunds, bonuses, and lottery. You can aggregate your windfalls (unexpected gains) into your emergency savings account to reach your goal fast.
These lump sums can quickly increase your funds, reducing the time needed to reach your target.
According to the IRS, the average tax refund in 2023 was around $2,800. Directing this refund to your emergency fund can be a substantial boost.
Reassess and Adjust Regularly
Regularly reassessing your emergency fund ensures it remains adequate. A periodical review of your emergency funds would ensure that the savings are adequate for your life changes, such as a new job, a new city, or new expenses resulting from the birth of your children.
You should ensure that an annual reassessment along with the periodical adjustments happens on time.
keeping a history of previous assessments and expense track records can help to address the percentage that you are going to increase or decrease from your budget.
Avoid Using Your Emergency Fund for Non-Emergencies
Resisting the urge to use your emergency fund for non-emergencies is critical. You should strictly consider that the emergency fund is solely for the emergency.
If you need to buy anything fancy, wait, earn first then go for it.
Having a separate account for discretionary spending can help maintain the integrity of your emergency fund.
For better money management, follow the 50-30-20 budgeting rule to avoid depending on emergency funds regularly.
Keep Your Fund Accessible but Not Too Accessible
Accessibility is key, but too much accessibility can be a pitfall.
The emergency fund you are maintaining needs to be liquid enough to encash during the need. However, being so accessible that you can easily spend it on non-essentials can strain the fund.
For this, you should maintain your urgency funds in a high-yield savings account that offers encashment opportunities with returns (APY).
Strongly avoid tying up your emergency fund in investments that are not easily liquidated without penalties.
Should you keep the emergency funds in cash form?
Emergency funds can be held in various forms. Common options include cash, savings accounts, and money market accounts.
Each form has its pros and cons. Cash is readily accessible but doesn’t earn APY. Savings accounts offer liquidity and interest but may have lower rates. Alternatively, money market accounts provide higher interest rates with similar liquidity but may have minimum balance requirements.
We are not asking you to keep all of your savings funds in one form. You should diversify the amounts across different forms. For example, when your emergency fund reaches its target (let’s say $10,000), keep 20% in a savings account, 10% in an envelope for easy access and put the rest into money market investment.
Such diversification would help you to match the urgencies as well as earn returns. Your job is to maintain a balance between liquidity and return. Do not opt for risky investments such as shares, cryptocurrency, or lending where your emergency liquidity may be under threat.
What is the tax implication of your emergency funds?
Earning and savings will always have tax implications depending on your local guidelines.
Typically, there will be no tax for just keeping balance in your account but, interest earned on your emergency fund in savings accounts or money market accounts is typically subject to federal income tax.
Ensure you report this interest on your tax return. Using tax-advantaged accounts like Roth IRAs for part of your emergency fund can offer tax-free withdrawals in retirement but consider penalties for early withdrawals.
Conclusion
Building an emergency fund is a must for your mindfulness. By setting a clear goal, opening a dedicated savings account, automating contributions, cutting unnecessary expenses, boosting your income, using windfalls wisely, reassessing regularly, and staying disciplined, you can prepare for unexpected financial hiccups.
Diversifying your emergency fund forms, understanding tax implications, and keeping the right level of accessibility can further enhance your financial security. You’ve got this!
