A $1,000 emergency fund is a great start to saving for unexpected expenses, but it’s probably not enough.
As a rule of thumb, you should save three months’ worth of living expenses for a secure emergency fund. For most people, $1,000 can be very helpful in times of distress, but it likely won’t cover what you need to pay in just one month, let alone three.
Some financial advisors recommend saving enough to cover you for six months. Of course, the more money you have in an emergency fund, the better.
How Much Money Should I Have in an Emergency Fund?
The ideal amount you should have in an emergency fund depends on your personal situation – how much you pay in rent or mortgage payments, the cost of your groceries and utilities and monthly bills like loan or credit card payments.
Add up all your monthly expenses and multiply by three to six and that’s about how much you should have at a minimum in your emergency fund.
An emergency fund is crucial to maintaining your financial health when life takes an unexpected turn. For example, you may face sudden hospital bills or lose your job and income. You may need to pay for a major car repair or fix a crucial appliance.
Without a little cushion to pay for your lifestyle during an emergency, you could get yourself into financial trouble. You don’t want to dig yourself deeper into debt to stay afloat. You may be forced to pay for necessities with a credit card, or take out a personal loan, which are not good options. More credit card debt multiplies your expenses.
Worse, you could get behind on paying your bills, and that can hurt your credit score for a long time.
So, having an emergency fund of liquid cash that you can access easily is critical to financial health.
Where Should I Put My Emergency Fund?
If you’re just staring to save an emergency fund, you’re going to need a place to put the cash.
A savings account is an ideal place. There, it’s protected by FDIC insurance up to $250,000. That means your deposit is safe because even if the bank fails, the government will cover the loss up to that amount.
In addition, you can earn a modest amount of interest on your savings accounts. High-yield savings accounts, which you’ll mainly find through online financial institutions, offer around 1.5% return on your deposit. While that’s not much compared to what other investments like stocks can make, it is a very low-risk way grow your money.
Just don’t mix your emergency fund account with an account you use daily. It’s not a good idea to consider extra money in your checking account as an “emergency fund” because you could easily spend that money on non-emergency purchases.
Some people like to have physical cash on hand instead of in an account. So, they may put their emergency fund aside, say in an envelope in their desk (hopefully in a locked drawer), or in a safe.
The key with holding hard cash is to make sure it’s not so accessible that you’re tempted to spend it, and that it’s well protected from theft.
How to Make a Budget
Creating a budget is absolutely key to saving successfully. Know your total monthly income and expenses. Make a detailed account of your bills and what you spend on necessities and non-necessities. Necessities include housing, utilities and food and any other bills, such as a phone bill or loan payments. Non-necessities include restaurant meals, clothing, accessories and entertainment.
Subtract your total monthly expenses from your total income. If you get a negative number, that means you are living above your means. You need to make cuts and/or increase your income.
If you have a positive number after subtracting your expenses from your income, you have some money you can allot to savings.
If you have credit card debt: It’s important that you focus on paying that down first. But that doesn’t mean you shouldn’t set aside funds for savings. Put a large portion of your extra income toward your credit card debt, hopefully paying more than the minimum. But also budget some amount – even if it’s small – to put toward an emergency fund.
One key to saving successfully is getting into the habit of saving. Even if you save small amounts, building a habit of saving will help you set aside money more easily. In the long-term, these habits pay off handsomely in the form of solid financial health.
Try to Reduce Monthly Expenses
If you need to cut back on expenses, you can do this in several ways. Review what you are spending your money on and see how you can pare back.
Are you buying restaurant food that would be less expensive than if you cooked from home? Can you use coupons at your grocery store? Can you reduce your water or electricity use to lower your bill?
Everyone’s situation is unique, but it would pay to take a close look every month at where your money is going. You can track your spending with one of many financial apps, like Mint.
Can You Improve Your Income by Earning Extra Money?
To improve your cash flow, which will give you more money to save for an emergency fund, you can look for some side hustles.
Some of the best side hustles are ones you create yourself. That way, you can have a flexible schedule with your extra work, like blogging or driving for Uber.
If you have some savings already, you may be able to earn more money by investing it in assets like stocks.
Can’t I Tap My 401(k) for an Emergency Fund?
You could tap into retirement accounts, but you shouldn’t. Increasingly, younger adults are staring to treat their retirement accounts, such as their 401(k) accounts as they would a checking account. That’s not a good idea.
If you get into a tough financial situation, it’s not that difficult to access those funds through a few online clicks.
However, you really want to avoid that strategy because it will cost you. When you put money into a retirement account like a 401(k) or an IRA, that money gets tax advantages, such as through income tax deduction. The idea is that the government wants to encourage you to save so you will be on strong financial footing when you retire.
Unfortunately, if you withdraw those funds before your retirement years, you will have to pay a penalty, especially if your investments have made gains.
The Bottom Line
It’s important to keep a positive mindset and create good habits about saving. Even saving small bits at a time can give you a good financial boost in a time of need.
The key is to develop a plan for how much you want to save, and then start setting aside your savings regularly.
Finally, plan in advance for what your emergency fund will be used for, such as for medical bills or car repairs but not haircuts or clothes. Once you get your habit of savings started, you can rest assured you’re on better path for a healthy financial future.