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What is an Emergency Fund?

What is an emergency fund?

 

If this sounds like you, don’t stress. The sooner you make a plan for building your emergency fund, the better prepared you’ll be to weather your next financial hiccup. Here’s a quick guide for boosting your savings account.

What is an emergency fund?

Let’s first clarify what an emergency fund is. Unlike your checking account, which is designed for paying bills and making everyday transactions, your savings account is more of a holding place. It’s a great spot to park money that you’re setting aside for short-term goals, like your next vacation or the down payment on a home. You can also use a savings account to build a financial safety net. This is the primary function of an emergency fund.

 

Instead of reaching for a credit card or borrowing money from friends or family, you’ll already have a pool of cash to see you through. What constitutes an emergency? It refers to any surprise expense that comes along and threatens your budget. To be clear, we’re not talking about overspending. (If you’re having a tough time sticking to your budget, reassessing your income and expenses can help you get on the right track.) With that said, an emergency fund might come to the rescue if you experience any of the following: 

 

  • Job loss or a dip in income
  • An unexpected car or home repair
  • A medical bill you didn’t see coming
  • A surprise tax bill

How much money should I have in my savings account?

The rule of thumb here is to set aside three to six months’ worth of expenses. If that feels like a lofty goal, that’s okay. The idea is to simply develop the habit of saving some portion of every paycheck. If you stick with it, that financial cushion will get bigger and bigger.

 

Revisit your budget to see how much disposable income you usually have left over each month. After all your bills are paid, how much can you reasonably funnel into your emergency fund? Settle on a target number that feels right to you, then treat it like any other bill. Starting small is fine too. Even if you can only spare $50 per paycheck, that still adds up to $100 per month — or $1,200 per year. And you can always dial up your efforts along the way.

 

Where should I keep my emergency fund?

Once you have a savings plan, it’s time to find the best place to keep your emergency fund. Hoarding cash isn’t the safest option, and you’ll lose out on the opportunity to earn interest on your savings. You’ll also want to steer clear of your checking account as you could be tempted to spend it. Similarly, tax-deferred retirement accounts like 401(k)s or traditional IRAs are out. Withdrawing funds before age 59 ½ will trigger a 10% penalty and a tax bill. 

 

Your best bet is likely a high-yield savings account. They generally offer higher interest rates than traditional savings accounts — this is what allows your money to grow even more. Just keep in mind that some banks require a minimum opening deposit to get started. 

 

 

Tips for building your emergency fund

Saving isn’t always easy, but these simple hacks can get you moving in the right direction. Consider incorporating the following action steps:

 

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