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How to Start Building an Emergency Fund
For many of us, recent events have come as a massive shock. Personal health concerns, loss of loved ones, loss of jobs, and uncertainty about many other jobs have turned a lot of people’s worlds upside down and, for many, it’s been a clear indicator of how valuable an emergency fund can be.
An emergency fund is a really simple concept: it’s just a pool of money you have set aside for life emergencies. You can decide for yourself what constitutes such an emergency, but generally, such emergencies include things like a job loss, a sudden illness, or any other major out-of-the-blue expense.
Most of the time, emergency funds are stored in savings accounts, usually at a local bank or credit union. It’s often a good idea to have such an account accessible when you need it, but not incredibly convenient at all times because that raises the temptation of withdrawing money for non-emergency uses.
So, how can you get an emergency fund started?
Open an account at a local bank or credit union.
You can do this online for many banks and credit unions, so it’s not required for this to be done in person.
I recommend having an account at a different bank or credit union than your primary one for the convenience reasons noted above. It’s great to have an ATM card for that account and it’s great to have a local branch for that account, but you don’t want it to be convenient. You generally don’t want to have access to your emergency fund when you’re out drinking or shopping. You generally don’t want your emergency fund ATM card to be in your wallet if you get robbed. Instead, keep that card at home in a secure place that you’ll only touch in an emergency.
You’ll likely need to transfer a certain amount into this account as an initial balance, which you can pull from your checking account directly.
The advantage of having an account in a bank or credit union is that the accounts are insured against the failure of the bank for up to $250,000 in value. Provided you just deposit cash into the account and withdraw it only in emergencies, it’s pretty safe in there.
Why not use cash? There’s nothing wrong with having a small additional cash security fund at home, hidden away somewhere, but cash exposes you to different risks than a savings account. Cash can easily be stolen without a trace. Cash can also easily be destroyed or lost in a natural disaster, like a fire, tornado or flood. It does have advantages — for example, it’s great to have a little in a period where there’s no electricity — but it shouldn’t be your only, or even your main, emergency fund.
Why not use a credit card? A credit card has yet another set of risks. It relies on the credit card issuer continuing to extend you credit. It’s also prone to identity theft and not having much balance available if you actively use it.
Given the various risks and issues involved, cash in a savings account is generally considered to be the best option for an emergency fund.
Set up a frequent small automatic transfer into this account from your main checking account.
I’ll leave it up to you to decide the amount. However, I recommend doing the transfer on either a weekly basis or one that lines up with your current pay cycle.
If you choose to transfer $10 a week, you’ll be moving $520 a year into that account.
If you choose to transfer $20 a week, you’ll be moving $1,040 a year into that account.
If you choose to transfer $50 a week, you’ll be moving $2,600 a year into that account.
This will give you some idea as to how fast your emergency fund will grow. It’s worth noting that, in a savings account, your money will earn a small amount of interest as it sits there.
Leave that automatic transfer on, and forget about the account until an emergency happens.
Simply stow away that ATM card in some secure place in your home, where you can easily retrieve it when needed.
Then, simply forget about the account. Be mindful of that automatic transfer, of course, but aside from that, just forget about this account. Leave the ATM card where it is. Don’t stop at that bank. Just let it build up, little by little.
When a genuine emergency strikes — you lose your job, your car dies or some other big unexpected event happens — then look at that account. Withdraw whatever you need from that account to take care of the problem. Turn off the automatic transfer for a while if you need to (it’s probably a good idea in a job loss situation).
I don’t think this will build up fast enough!
Part of the challenge of building an emergency fund is that, at first, there just isn’t a whole lot of money in there. Unless you happen to have a fistful of cash just sitting around that can become your emergency fund — and that’s simply not true for most Americans — you’re not going to have a whole lot in there at first.
The easiest way to accelerate an emergency fund is through short-term frugality. Many Americans are cutting back heavily on their spending right now, whether by choice or by simply not having options to spend, and this provides a perfect opportunity to provide some initial fuel for that emergency fund. Beyond the automatic transfer, make an extra deposit right now with the money saved from your recent frugal choices and you’ll find that balance ballooning quite quickly. To start, here are the best high-yield savings accounts of 2020.
When should I turn off the automatic transfer? When will it be big enough?
My simple answer? Never turn it off.
Don’t worry about having some “target number” for the balance of your emergency fund. Just let it grow and grow.
Think about it this way.
Imagine your monthly living expenses for your family are $3,000. Even if you’re contributing $20 a week, it’ll take you about three years for your emergency fund to cover just a month of living expenses. If you tap it for anything else, it’ll take longer.
For your emergency fund to really be there for you in a big emergency like a job loss or an illness or a major car breakdown, it needs to have a healthy balance. If you empty out that balance, there won’t be anything around for the next emergency.
Instead, treat your contributions as simply “paying yourself first.” You’re putting that money aside, every single week, for when things go awry at some point in the future. Sure, you might go for years without having to tap it, but you can rest assured that when things do go awry, you have a pretty big ace in the hole.
The secret benefit of an emergency fund is the peace of mind.
An emergency fund isn’t just helpful when you’re in an emergency. It’s also helpful just to know that it’s there in case an emergency comes up.
If you don’t have an emergency fund, a big unexpected car repair can be a huge worry. Starting your car and hearing an unusual sound turns into a prayer that nothing’s really wrong. Even the thought of situations like that can be enough to cause some background stress in your life.
On the other hand, with an emergency fund, you know that if something goes wrong like that, you’re in good hands. There’s no need to go into debt. There’s no need to panic. Just deal with the issue and move on with no major life disruption.
That brings peace of mind. That eliminates a real thread of worry that’s constantly running in the minds of many. That’s the power of an emergency fund.
If you don’t have one, get one.
There is no better time than right now to get an emergency fund started for yourself. Sign up for a savings account at a local bank or credit union (you can do this online in many places), transfer in some starting funds, and set up an automatic weekly transfer into that account.
Then sit back, let the emergency fund build, and you’ll soon have a nice layer of protection against life’s unknowns.