What is an Emergency Fund

Emergency Funds: Everything You Need to Know

“Ahhhh”, I winced in agony, knowing it was too late. My fate had been sealed, or rather the fate of my tires. I was driving my brother to drop him off at the airport when I slammed into a pothole on the passenger side of the car. In retrospect it more like a sinkhole, mercilessly engulfing anything that tried to pass. I frantically tried to veer out of the way, but I was boxed in by cars in the lanes on either side. I clenched my hands on the wheels and closed my eyes for a split second as I braced for impact.

As if on cue, the car started to wobble and the unmistakable rattling of the wheels signaled that a tire had blown out. Seeing that both passenger wheels exploded on impact in rapid succession was the final nail in the coffin. As five other cars pulled up behind us within a few minutes, having realizing the same fate, the first thing we were sure about was that the pot holes in Philadelphia are in a league of their own. The second thing I was sure about was that I’d be dipping into my emergency fund.

Our Emergency Fund Turned A Disaster Into A Nuisance.

reasons for emergency fund

Wondering what is an emergency fund? Look no further than Forrest Gump, one of our favorite movies! At this point, it’s old enough to be a classic, but it’s full of life lessons. One reason we love it is because Forrest understood how important it was to have an emergency fund. After all, it was Forrest Gump who said:

“Life is like a box of chocolates, you never know what you’re going to

get”.

What Is An Emergency Fund?

An emergency fund is a fancy word for money set aside in case of an emergency or unexpected expense that can’t be delayed. Some people think of their emergency fund as a minimum balance or a floor for their savings, which they don’t allow themselves to dip below (unless it’s a last resort). In this post, we will dig into which types of accounts are great for this, and how much you should save, but first, let’s discuss why you even need one. Isn’t a credit card a good enough back-up source for cash? No!

Why Do I Need an Emergency Fund?

Life is unpredictable. It is full of amazing experiences, like when your favorite team wins the Super Bowl or World Cup. Or the person you have a crush on says yes to go on a date. On the other hand, cars get towed, unexpected bills pop up, or you get sick on a hiking trip.

Most Americans don’t have $500 in savings. This means that an unexpected bill can set you back months or years if you start racking up credit card debt just to get by. Interest on a credit card can be more than 20%, which is freaking insane. Like, so insane you’d be set for life if you could loan money at those kinds of rates. Credit card debt is a slippery slope you need to avoid at all costs.

Emergency events often happen unexpectedly and give you no time to prepare. That’s when the emergency fund steps in. Pop a tire on a huge pothole driving to work? The emergency fund can help cover the cost. An unexpected event can make a huge impact on your life. If your car breaks down and you are unable to cover the repairs, you may lose the ability to get to work and lose your job.

The point of an emergency fund is to protect you from extended hardship. An emergency fund will help you get back on your feet as quickly as possible.

Saving up a little bit of money each month can help protect you, your family, and your future. This is why saving an emergency fund should be your #1 priority. Even before saving for retirement. Put as much money into your emergency fund as you can to begin with.

How Much Should I Set Aside in my Emergency Fund?

How much you set in your emergency fund depends on your income and how much you spend each month. Early on you may only be able to set aside $120 by saving $10 each month for a year. Setting aside $40 each month can add up to nearly $500 after a year. This will put you way ahead of your peers!

If you depend on a car for your daily obligations (going to work, grocery shopping, etc.) you should set aside $1,000 as quickly as you can. Car repairs are often expensive and essential depending on where you live.

Once your initial emergency fund is saved up, you should save enough money to cover your basic living expenses for 3 months.

Basic living expenses are your rent, groceries, minimum loan payments, etc. This ensures you are protected in case you lose your job or are disabled in an accident. Disability insurance can help you if you become disabled and cannot work. However, they often do not start paying you for 3 months. If you have disability insurance through your job, look into how long the waiting period is before you would receive payments. Saving up enough money to cover your expenses during the waiting period is a good idea.

Not everyone is able to save up that much money in an emergency fund overnight, but the key is to save regularly. You should save the money in a different account than the one used for daily expenses. Leaving the money alone is just as important as putting it into the emergency fund, so that it is still there for a true emergency.

It is also important to replenish the account after any emergency. The goal is to always keep the emergency fund at your target level or be working towards reaching it. This is true regardless of how much money you have. Even Bill Gates should set money aside in case of an emergency.

What Type of Account Should I Use For An Emergency Fund?

Hopefully you will not need to use this money very often (hopefully less than once every few months). Because of this, traditional low-interest checking/savings accounts are not the best choice. This is because their interest rates are basically 0%. These are the banks like Wells Fargo, Chase, Bank of America, etc. The big dogs. Sadly, the big dogs don’t always play nice. Aside from low interest rates, they often come with balance minimums and other requirements as a way to charge you a fee. The last thing you want to do with your hard earned money is pay more fees!

If you’re going to be setting money aside, you might as well make as much money from it, and every penny counts. Every damn penny! It sounds insane, but things add up, and over years of working, a single penny can compound into several pennies, which compounds into dollars, which then compounds to lots of dollars!

We like to use savings accounts at an online bank for a few reasons.

They tend to have better interest rates than the large national banks and sometimes even smaller local federal credit unions. Try to find a savings account with at least a 1% annual interest rate. It is also critical to find a bank without minimum balance requirements or other fees for your emergency fund. Banks like Ally or Capital One 360 are great options for this. They offer interest rates that are WAYYY higher than traditional banks and have no monthly fees. Boom.

There’s no point in opening a savings account if the bank will take some of your money away in monthly fees. Another big advantage of online banks is that if you move you don’t have to worry about switching banks every time. We both moved to new cities for college and business/med school. Throughout all the moves we were able to keep our online accounts (though we did open and close brick and mortar checking accounts multiple times, until switching completely to online banking).

Where Do You Keep Your Emergency Fund?

The online bank we personally use is Capital One 360 Savings.

The interest rate is 1.75% on balances over $10K and 1% anything smaller, which is great. There are no minimum requirements and no yearly fees. Remember that this is a savings account so you need a checking account to access cash via an ATM. You can link your savings account to your checking account (does not have to be a Capital One checking account) to put money in or transfer it out.

Capital One also have a large ATM network (they have ATM partners) so when you need to use the money, you can simply find a nearby ATM to get the cash if you also have a Capital One 360 checking account. Ultimately, we lived in cities that had Capital One locations making it convenient to stop in if needed. Admittedly, we have literally never actually walked into the branch for anything. One thing to note that won’t affect most people, is that you can’t make more than 6 withdrawals per month from savings accounts. Emergency funds shouldn’t be withdrawn regularly so this shouldn’t affect you, but if you think you’ll be taking money out a lot, stick with a checking account.

Ally Bank is another great option with a slightly higher interest rate of 1.25% for their online savings account and worth a look.

Many employers have credit unions affiliated with them in addition to local credit unions near where you live. Be sure to check their rates as that might be more convenient for you. If we find another bank with significantly higher interest rates and no minimums or fees, we may switch there.

In general, the interest rates on savings accounts are going to be pretty low. The MOST IMPORTANT factor for your emergency fund is to find a bank account with zero monthly fees.

Thank you for reading our post on starting an emergency fund! If you have questions or comments please comment below. If you have an emergency fund and are curious what else you can do, check out our personal finance guide! It’ll help you prioritize personal finance decisions, so you can continue to rock them.

Question for you: Where do you plan to keep your emergency savings?

Source(s):

[1] http://money.cnn.com/2017/01/12/pf/americans-lack-of-savings/index.html

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