Personal Finance Sep 21, 2021 01:04 PM EDT

Why You Need an Emergency Fund and How to Build One

By David Thompson

Why You Need an Emergency Fund and How to Build One
Why You Need an Emergency Fund and How to Build One (Photo by Karolina Grabowska from Pexels)

Following the pandemic, natural calamities, and major employment shifts, a startling new study on the online news site News Nation shows that 1 in 4 Americans don't have an emergency fund. What's more, those reportedly making under $30,000 were likely to have no savings at all. Of those in the study who did say they still had emergency savings left, what they have is reportedly worth less than three months of their salary.

What is an Emergency Fund Anyway?

For starters, an emergency fund is not the same as your investment fund, your savings, or your nest egg. Reputable finance site AskMoney explains that an emergency fund is money set aside to cover unexpected expenses. This can include sudden medical emergencies, living replacements, vehicular repairs, and changes in employment.

Note that not all emergency funds are the same. Its size varies from person to person, but generally speaking, it must cover up to six months worth of living expenses. Some important factors to help determine the appropriate size of an emergency fund are your current lifestyle, whether you have dependents or not (furry friends, included!), your work situation, and your debt and cash flow.

Why Do You Need an Emergency Fund?

Having an emergency fund not only provides you with financial security but also living stability. As we mentioned in our previous post on '2021's Worst Money Mistakes You Can Make with Your Salary', an emergency fund can protect and provide for you in case of a loss of income. On top of this, an emergency fund can also protect your other financial assets from being accessed in an untimely manner. For instance, rather than having to touch your retirement fund or selling a personal item to pay for sudden expenses, an emergency fund can cover this and leave your other assets untouched.

How Can You Start Building an Emergency Fund:

Open a high-interest savings account

Gone are the days when piggy banks were the safest place for your rainy day fund. Instead, your modern-day emergency fund is much better off in a liquid and safe state. Hence, when beginning your emergency fund, it's best to open a high-interest savings account. Unlike a long-term investment fund, these savings accounts are easy to access and typically don't have any penalties for early withdrawals. Plus, depending on the financial establishment you work with, you may even want to opt for an account that promises higher interest rates. Take note, though, that higher-interest accounts may mean your money is being invested in relatively "riskier" investments. However, so long as your bank assures that the amount of money you put in is always available to you-whether it has grown yet or not-then it's a viable and possibly, profitable, option.

Establish how much your emergency savings should be

As we said earlier, the exact amount of an emergency fund varies depending on the person. Before you start putting money aside, though, you must determine what the right emergency fund amount is for you and how long you plan to save up to reach this number. Much like how you'd plan to save for a new car, you'll also want to set a specific amount to be set aside at pre-determined intervals. One of the main things you'll have to take into account is your payables on updated essentials. This means your rent, food, contributions, and healthcare. For instance, since the recent report by the government agency U.S. Bureau of Labor Statistics shows that housing expenditures have increased by 3.5%, make sure that your emergency fund will be able to cover this increased cost, among others.

Rework your budgets to eliminate unnecessary spending

As of January this year, a report from CNBC showed that despite only 4 in 10 Americans having enough money set to cover an unexpected $1,000 bill, only 18% said they'd reduce their spending to put together the necessary amount. However, one of the easiest and most effective ways to start putting money into an emergency fund is to re-divert unnecessary expenditures towards it. For example, savings app Acorns says that the average American spends over $2,000 annually on coffee runs alone. By simply cutting your coffee spending in half, that's already more than one grand in your emergency fund.

Be patient with an emergency fund. Growing it isn't always fast, and it's definitely not as exciting as saving for a vacation or a new house. However, having an emergency fund does offer you the invaluable confidence that you will be secure even if the going gets tough.

For more saving tips, financial news, and money guides, check out our other resources on Money Times.

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