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By Alliant Credit Union
Life is full of ups and downs. While ups are pleasant, downs like unexpected financial setbacks can be quite challenging. Setting up an emergency fund can be crucial so you’re prepared for times of financial stress. Learn about this financial safety net, why it’s important, and how you can start building an emergency fund.
According to Bankrate’s 2024 emergency savings annual report, only 44% of Americans can afford to pay $1,000 or more for an emergency from their savings. By having an emergency fund, you’ve already set aside a specific amount for those situations. When an emergency strikes, an emergency fund helps you avoid debt.
Imagine the following scenarios:
These emergencies can take a sizeable chunk out of your finances. Without an emergency fund, you might struggle to afford basic daily expenses during your job search. Or it might be difficult for you to cover the considerable costs for your car, your home’s heating system or your tax liabilities. You might also be tempted to take out a high-interest loan or a cash advance on your credit card, which can lead to a cycle of debt that’s hard to break and only adds to your financial burden and emotional strain. Plus, consistently relying on credit can damage your credit score, leading to unfavorable financial consequences in the long run.
An emergency fund is not just a financial tool–it’s critical for your financial well-being and designed to help you weather unexpected financial setbacks with confidence and security.
The critical characteristic of an emergency fund is that it should be readily accessible. This is why it’s advisable to keep your fund in a savings account instead of having it tied up in investments.
Investments like stocks, bonds or mutual funds can be great options for long-term financial growth. However, they do come with risks due to their volatility. Their value can fluctuate significantly, making them risky as emergency funds because you need your emergency fund’s value to be stable.
Additionally, investments are not always liquid. This means converting them into cash for emergencies can take time. In a crisis, every moment counts, and waiting several days to liquidate investments can exacerbate the situation.
By nature, emergencies can happen without any warning and can require a large amount of money to cover. A savings account is undoubtedly invaluable during emergencies as it allows you to easily access your money and withdraw much-needed funds at any time.
Additionally, having immediate access to your emergency fund is more than just about convenience – it’s about avoiding extra stress and anxiety in an already challenging situation. The last thing you need in an emergency is the added stress of financial worries.
Clear separation from other funds for other purposes. An emergency fund is not for impulse purchases or daily expenses. By keeping it in a separate savings account, you can avoid dipping into it. The last thing you want to deal with in an emergency is finding out that you’ve depleted your emergency fund due to non-emergency expenses.
Easier fund tracking and management. Having a savings account solely for your emergency fund would make it much easier for you to monitor how much you have saved up and how close you are to your savings goal for your fund.
Easier fund tracking and management. Keeping your emergency fund in a dedicated savings account can help it grow incrementally over time, thanks to accrued interest. Though savings accounts offer lower interest rates compared to investments, savings accounts are, by far, more stable and accessible.
Determining how much you should store in your emergency fund is crucial. Let’s walk through some steps to help you determine the amount your emergency fund savings account should have.
First, identify your essential monthly living expenses. These could include rent or mortgage, utility bills, groceries, insurance payments and transportation costs. Think about the must-haves or necessities that keep your household running every month.
Consider personal and family-specific expenses, such as childcare costs, healthcare expenses like prescription medications, and ongoing debts like credit card payments.
Other essential expenses include car maintenance or occasional home repairs. Though these may be less frequent, they do add up significantly, so it would be wise to consider them.
Once you’ve identified these expenses, estimate how much you spend on each type of expense every month, and then add these all up to get the total cost of your monthly living expenses.
After multiplying your monthly living expenses by 6 to 8, you’ll end up with the ideal amount you should put into your emergency fund. Why 6 to 8? This range is generally recommended to provide you with a safety net in case of significant disruptions so you can figure things out without the pressure of immediate financial hardship.
Your emergency fund should be substantial enough to offer flexibility during emergencies so you won’t need to resort to high-interest debt options. Remember, though, that the “right” amount for your emergency fund depends on your personal circumstances, such as job stability, lifestyle, monthly costs, and any other safety nets you have, like income from a working spouse.
Selecting the right type of savings account is crucial to ensure your emergency fund’s effectiveness and growth. Here’s a brief overview of regular savings accounts and high-yield savings accounts.
Typically, regular savings accounts offer lower interest rates. However, they offer high reliability and accessibility while providing you with a safe place to store your funds. Regular savings accounts don’t offer substantial growth over time, but they keep your funds secure.
On the other hand, high-yield savings accounts are similar to regular savings accounts, except that high-yield accounts provide higher interest rates. Some high-yield accounts have specific requirements, such as required minimum balance, but they still provide you with easy access to your funds, much like regular savings accounts.
To answer the question above, a high-yield savings account would be the most appropriate for storing your emergency fund because of the following benefits:
Having your emergency fund in the right savings account provides financial security and peace of mind, as you'll know you're well-prepared for life's unexpected turns. If you're ready to save, Alliant offers several convenient ways to open a high-yield savings account. If you're already an Alliant member, log in to online banking and select Open a New Account in the left sidebar and follow the prompts. If you're not yet a member, review our savings account or supplemental savings pages for steps on how to apply.
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