How much emergency fund should I have?
Financial experts recommend that individuals have an emergency savings fund.
This means saving money to create an account with enough money to cover three to six months' worth of living expenses. If you do not have an emergency savings fund you would need to apply for an emergency loan, which is a type of personal loan.
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What is an emergency fund?
An emergency fund is an amount of money set aside to pay for emergency expenses, such as medical bills, home repairs, vehicle repairs or purchase of a new vehicle, and living expenses in the event you are unable to work.
Why is having an emergency fund important?
The goal of an emergency fund is to have money available for quick, easy access so you do not have to borrow money in the event of a physical or financial emergency or job loss.
Having money set aside provides peace of mind and can save. For example, if your car breaks down and you suddenly need to make thousands of dollars of repairs, having emergency money in your bank account means you won’t need to take out an emergency loan or borrow money. Many people pay for emergency expenses with a credit card but are then unable to payoff that bill in full, which means paying high interest on the debt.
How to build an emergency fund
Knowing how to start an emergency fund can seem a little intimidating, but it’s really very easy.
Set a savings goal. Calculating an emergency fund starts with comparing your monthly earnings and expenses to see how much money you have left after your bills are paid. From the money left, decide on a savings goal and how much you can afford to put into an emergency fund. For example, if your goal is to have $5,000 in an emergency fund after 12 months, you’ll need to save $416 each month.
Create a budget. To help you stay on course to meet your savings goal, create a budget. This can include how much money you can spend on things like vacations, dining out, and other expenses.
Cut back on spending. Cutting out unnecessary spending, such as impulse buying can help you reach your savings goal sooner.
Increase your income. Taking a second job or seeking higher paying employment is another way to reach your goal sooner.
Consider automating your savings. Automating your savings removes the temptation to spend outside of your budget. This essentially means “
paying yourself first,” by setting up your bank account to have a specific amount of money automatically transferred into your savings account each month. For example, this can be done through direct deposit into your savings account or by going into your account settings and selecting “account transfers” to transfer a specific amount each month from your checking to savings account.
Monitor your progress. Be sure to monitor your checking and savings accounts to make sure you have the money you need each month to pay your bills in full, so as not to accrue debt in the effort to save money. You may realize that you’re able to put more into savings, or you may need to reduce your savings to have a better bill-pay cushion. Don’t worry. All efforts to save money are a great step forward, no matter how much you contribute.
Stick to the plan. Saving money requires a commitment to reach your goal. If along the way you find you’ve overestimated how much you can afford to set aside for emergency savings, it’s perfectly okay to recalculate and set a new budget.
Celebrate! The goal is to save money and any savings is a victory.
Where to keep your emergency fund
Emergency fund money should always be in an easily accessible savings account at a credit union or bank. Certain
types of savings accounts earn higher interest than others. With that in mind, consider keeping your emergency fund in one of these accounts:
High-yield savings account. This type of account pays a higher interest rate on larger balances maintained in the account.
Money market deposit account. A
money market account is a type of savings account offered by credit unions and banks. Money market accounts are sometimes referred to as money market deposit accounts and money market savings accounts. Money market accounts are interest-bearing, meaning that interest is paid on the account balance.
You cannot lose the balance of a money market account.
Money market mutual fund.
A money market account is a type of savings account that provides liquidity and earns interest on the principal. A money market fund is a type of investment account that invests in funds that may gain and lose value, meaning you could lose part of your initial investment.
What to avoid
An emergency fund should be quickly and easily accessible so you can access your money as soon as the emergency occurs. These are places to avoid storing emergency funds:
Checking accounts. These accounts are for managing your earnings and expenses. Mingling your savings with checking makes it difficult to keep track of your savings.
The stock market. Money invested in the stock market may be lost due to fluctuating value of stocks.
Certificates of deposits (CDs). A certificate of deposit is a type of savings account that is offered by banks. CDs work the same as
share certificates, which are offered by credit unions. Share certificates have a specific term (timeframe) that the money must remain in the account, during which a specific dividend rate is earned. In an emergency, you may not be able to withdraw your money easily or without penalty.
Keeping cash at home. While it’s convenient to have some cash on hand, keeping large amounts of cash at home is not safe, as it could get lost or stolen. You’ll also lose out on earning interest.
When you should use your emergency fund
The money in an emergency fund may be used to pay for medical expenses resulting from major illness, injury, and hospitalization, to make major repairs to your vehicle or purchase a new one. Although your initial payments may be made with a credit card, you can pay the bill in full using your emergency fund, so as not to accumulate high-interest credit card debt. Emergency funds may be needed to cover household expenses if you lose your job and until you find a new job.
Is it possible to save too much?
While saving money for emergencies is very important, it is possible to have too much money in your emergency fund.
Opportunity cost. Keeping money in a high-interest savings account is good, but you’ll lose the opportunity to grow your money in other investments, such as stock market, real estate, etc.
Depreciation. If the interest earned in a savings account is less than the inflation rate, your money depreciates in value over time.
Insurance limit. Bank account deposits are
insured by the Federal Deposit Insurance Corporation (FDIC) and credit union deposits are protected with NCUA insurance. This is known as credit union deposit insurance. Consumers who use banks and credit unions are insured up to $250,000 per account. If you have more than $250,000 in one account, that money wouldn’t be insured in case of a bank failure.
What to do after you've created your emergency fund
Here are some recommendations for other meaningful ways to use the extra money you’ll have after you’ve established a healthy emergency fund.
Pay off debt. Student loans and high-interest credit card debt should be paid off as soon as possible, so you don’t lose money.
Invest in retirement. Consider opening a
Roth IRA or
traditional IRA to set money aside for retirement.
Save for a house. With your emergency fund, retirement funds, and debt in a good place, it’s a good time to save for a home, a second home, or make updates and repairs to your existing home.
Save for a vacation. While saving money is important, it’s equally important to take time to enjoy life. Reward yourself with a vacation.
Why savvy consumers choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including mortgages, Home Equity Loans, HELOCs, car loans, personal loans, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation loan consultation with a CU SoCal Member Services specialist.
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