No matter how hard you might try to avoid them, financial emergencies happen to everyone. After all, you can’t always anticipate or plan for everything life might throw your way.
That’s why everyone should have an emergency fund—a cash reserve to provide a critical safety net (and peace of mind) whenever life takes an unexpected turn. Proactively building a strong emergency fund can help you tackle unexpected challenges that might get in the way of reaching your financial goals.
Emergencies happen. Financial emergencies include things like unexpected car or home repairs, medical emergencies or even job loss. Any of these situations could bring financial setbacks that might take some time to recover from.
While you can’t control what unfolds, you can control how you financially prepare yourself for these types of events. An emergency fund essentially provides you some measure of control over an ostensibly uncontrollable situation.
The size of the cash reserve you need depends on your financial situation, including your monthly expenses, family size and other variables. As a rule of thumb, many financial advisors recommend having enough to cover three to six months of living expenses. Some essential living expenses to think about covering include your rent or mortgage payment, existing loan payments, average utilities, average grocery bills and any other necessary expenses each month.
Whether you need a large or small emergency fund, building your cash reserve can be accomplished over time through patience, discipline and consistency.
If you’re just starting out, know that every little bit helps when you're trying to reach any kind of savings goal.
To begin, see if there’s any wiggle room in your budget. Even cutting back $25 a month is a good start. Are there discretionary expenses that you could cut back on or do without? The extra money you save from trimming your budget can be reallocated toward your emergency fund. If you have access to Ayco through your employer and need help identifying areas in your budget to trim, consider taking advantage of our digital platform or speaking with one of our Ayco coaches to analyze your spending.
If you’ve already started to put some money away but want to save more, in addition to revisiting your budget, there are a few things you can do to prioritize your emergency fund savings. Think about scheduling automatic transfers to your savings account every time you get paid. Setting aside your tax refund or bonuses from work could also give your savings a boost.
One option is keeping your emergency fund in a high-yield savings account. You can earn interest and still have access to your money when you need it.
Tip: It’s a good idea to keep your emergency fund separate from your regular savings or checking accounts because you don't want to mix up the money you regularly use with funds you need for your safety net. Having a dedicated savings account can also help you easily track your progress toward your savings goals.
Remember—an emergency fund is really intended for unexpected expenses. So here’s the question you must ask yourself first before reaching for the money that’s in the account: Is this a real emergency?
Everyone’s definition can vary. This is why you might want to consider setting up some ground rules for when you’re allowed to access your funds. For example, if you’re in a situation that requires you to act immediately, it’s probably an emergency.
Avoid using your emergency fund for predictable events or recurring payments because these things should already be a part of your budget and you shouldn’t have to dip into your emergency fund to cover them.
Building up a cash reserve takes time, patience and discipline, but it’s well worth the effort. Your future self will thank you for your foresight and preparation when you’re able to lean on your cash reserve in times of financial uncertainty.
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Updated for tax year 2020
Updated for tax year 2019