Fit Finance: How to build an emergency fund, how much to save for it and how to avoid spending it
We've been taught to expect the unexpected, and when it comes to finances, the best way to do that is with an emergency fund.
An emergency fund contains cash for unforeseen moments "that throw your life into financial uncertainty and disarray," said Rebecca Jarvis, ABC News' chief business and economics correspondent. These could include a death in the family, a debilitating illness, a divorce or a job loss.
"Life is full of surprises and sometimes they have a giant price tag," Jarvis said.
How much should you save in your emergency fund?
Jarvis points out that emergency funds should be for "hurricanes" as opposed to "rainy day" inconveniences such as car repairs or broken appliances or phones.
"You want to look at your weekly budget -- how much are you spending on food and groceries? What is the cost of electricity and utilities? How much do you have to pay for rent or your mortgage? These are all necessities, things that you would have to make payments on in order to keep the status quo," Jarvis said.
She recommends building up six months' worth of these expenses for your emergency fund.
"But if you can't get there right away, at least [try to] have three months worth of savings to cover all the necessities," Jarvis said, noting that if you have children or job instability, you may eventually wish to save a larger padding.
If that total is a challenge, "it can be helpful to start with a smaller number, like $500, which can still be crucial in getting you through a difficult time," said Kimberly Palmer, a personal finance expert at NerdWallet, who shared a calculator that can help determine an amount you can strive to reach.
"The goal here is to give yourself that cushion so that you're not shouldering the financial burden, along with the emotional burden, of these major lifestyle changes," Jarvis said.
"Knowing that the money is there if you need it creates a peace of mind and a freedom to live in the present and not be thinking constantly about what happens in the future if you don't have this safety net," she said.
Where to put your money and how to save
Even though your emergency fund is a last resort, that money should be ready to deploy at a moment's notice, Jarvis said.
A savings account or a money market fund are options to contain your emergency fund, as are CDs, 401(k)s or even IRAs, but some of these can have fees associated with them for early withdrawals.
As far as contributing toward your emergency fund, Jarvis suggests making it a part of your budget.
"Give a little to that emergency fund every week, every month, until you get to the point where you have those six months of savings on hand," she said, further suggesting tracking and celebrating your progress along the way.
And if you're carrying a lot of debt, Jarvis recommends building your emergency savings, even if you have to scale back on debt payments.
"You should be building out that emergency fund before you build out anything else, because it is going to be the underpinnings of having some degree of security and knowing that if the unforeseen crops up, you have the ability to take care of yourself and your family," she said.
"Having that emergency savings fund can help prevent you from accruing even more debt if you face an unexpected emergency," Palmer added.
"If you don't have an emergency savings fund or you've depleted your emergency savings fund, create that line item, that small amount in your budget where you are consistently setting a little bit of money aside so that when and if you need it again in the future, you have it," Jarvis said.
Additionally, Palmer suggests taking a look at your spending on "wants" each month, which can include eating out, subscriptions, clothing, etc.
"If you can cut back on those categories and redirect the money into savings instead, it can be a great way to build up your emergency fund," she said, noting the 50/30/20 budget plan to assess and reallocate your funds.
Protect your hard work
"In general, you should keep your emergency fund for true emergencies and have other [long-term and short-term] savings accounts for other goals, such as vacations or big purchases," Palmer said. "Keeping it in a savings account designated for emergencies instead of your daily checking account can be one way to help keep it separate."
And also make sure you're assessing "emergencies" with a clear head.
"Here's a good barometer: Consider whether you actually need something to survive. If you don't, it's not an emergency," Jarvis said.
"Building an emergency savings takes work and the last thing you want is to undo all of that hard work with a decision on the fly," Jarvis added. "Going on a cruise is not an emergency."
Editor's note: This was originally published on Jan. 18, 2021.
