Would replacing a flat tire throw your finances off course this month? What about an unexpected trip to the emergency room? Or a sudden job loss? You’re not alone. According to the Federal Reserve’s 2024 Survey of Household Economics and Decisionmaking, almost half of U.S. adults (46%) have no emergency savings. The best time to start building an emergency savings fund is right now, before that financial shock happens. Yahoo Finance explains how starting an emergency savings fund can be a financial lifeline, the steps to take that make sense based on your financial situation, and how to ensure it remains a source of backup funds.
It happens to us all, an unexpected expense that the paycheck just won't cover. A leaky roof, a broken appliance, a flat tire, or worse. Having an emergency fund on hand can quickly diffuse a potential financial crunch. Yet almost half of US adults, 46%, don't have three months of emergency savings, according to the Federal Reserve. With all the cost of living and advice to put every dollar towards bills, paying off debt, and investing, here's how to realistically build an emergency fund.
The Consumer Financial Protection Bureau defines an emergency fund as a cash reserve specifically set aside for large or small unplanned bills or payments that are not part of your routine monthly expenses and spending. The biggest hits to the bank balance are medical bills and car repairs, at the top of the list, losing your job.
Going on vacation, that's not an emergency. Needing a repair to your roof or losing employment or losing an income stream, that's more of an emergency situation.
That's Larry Sprung. He's the founder and wealth advisor at Mitlin Financial.
I think people, you know, tend to address emergencies in a multitude of ways. Some people may go immediately to the credit cards and start bringing up credit card debt for those emergencies. On the credit card side, it comes with very high expenses to, you know, fund that emergency.
In fact, the Federal Reserve found that more than a third of US adults could not cover a $400 emergency with cash. And 16% of those individuals would use a credit card and then carry a balance to pay for unplanned expenses.
That emergency may be $10,000, but after you put it on the credit card, factor in interest and the time to pay it off, it could be $10,000, $15,000, $20,000 to actually pay for and finally pay off that emergency.
So how much will you need for an emergency fund?
The common quote unquote rule of thumb is three months roughly, and that's a good starting place. Now, if you're somebody who's self-employed, I would say three to 12, maybe even longer than that, depending upon your risk tolerance in terms of absorbing that emergency if it were to happen.
To start, grab your bank statements from the past three months to give you an idea of your spending habits. Highlight your fixed expenses from your bank statement, the ones that stay consistent each month, and drop in the average number. For this example, we'll use the average monthly expenses for a US adult based on the most recent government data. So use your monthly rent, utilities, insurance, loan payments, and subscriptions. Add those up, and you get $3,100 in fixed expenses each month. Now let's move to variable expenses, where the amount tends to vary more widely each month. That's usually dominated by groceries, dining out, transportation, entertainment, personal care, and miscellaneous goods and services. Total these, and you get $1,149. Combine your fixed and variable expenses to find your total monthly expenses. In this example, that's $4,249. Experts recommend an emergency savings fund to cover three months of expenses. For our example, that's $12,747. The idea of coming up with three months of expenses can seem out of reach, but every dollar saved gets you one step closer to being better prepared to withstand a financial shock.
Automating anything is extremely helpful, especially when it comes to finance. We set it, forget it, so it refills that bucket automatically.
And when you do have to dip into your emergency funds, prioritize replenishing it as soon as possible.
If you get a tax refund, that might be an easy way to replenish it. You should also really incorporate that back into your budget. Reconfigure it and include how much you can put in monthly towards that emergency fund.
Also consider where to keep your emergency funds.
Where it should be is in some liquid type of investment that's easily accessible, like a money market or savings account, or even a high-yield money market.
Your emergency fund should adapt to changing economic conditions. Regularly review and adjust the amount you save based on inflation, changes in income and monthly expenses. Starting an emergency fund is a process, but having one can make a huge financial difference.
It is so helpful to have that emergency fund in place to alleviate a lot of the financial strain that you or your family may have during that difficult time. It can be so vitally helpful to your financial success long-term.