Building Your Nest Egg: An Emergency Fund

Building Your Nest Egg: An Emergency Fund

Finance 101: 

Paying your bills, sticking to a budget and saving for retirement are all important tenets of personal finance. But what about those unplanned emergencies that require money when you’re least expecting it? What would you do if, for instance, you lost your job unexpectedly? Or maybe your car needs repairs or your refrigerator stops working. To protect against emergencies like these, you can develop an emergency fund. An emergency fund is exactly what it sounds like, an easily accessible savings account to tap into in an emergency. 

Building your nest egg may be your first priority, even before debt repayment and retirement savings, or you might want to set your other financial goals in motion before focusing on an emergency fund. Some people attack both debt repayment and emergency savings at once.

How to Succeed

Getting started on building your emergency fund is as easy as opening a savings account. Decide how much you can contribute to it from each paycheck and stick to your goal. Consider these tips for building your fund:

• It may be easier to automate your finances so you don’t actively have to transfer money each week.

• Another strategy is to think of your emergency fund as a monthly bill that you must pay to yourself.

• A painless way to start your account is with a tax refund, work bonus or other financial windfall.

• If you pay off a credit card debt or car loan, reroute the money you were using to make those payments into your emergency fund. Similarly, if you get a pay raise, avoid lifestyle inflation and put the additional income in your savings.

• Carefully define “emergency” to make sure you’re not withdrawing from the account unnecessarily.

• If you do experience a financial emergency, do anything you can to pay for it without tapping into your fund so you won’t have to rebuild it.

How Much to Save

There are many rules of thumb to use when deciding how much to keep in your emergency fund. If you don’t save enough, you could face financial hardship in an emergency and be forced to rely on credit. If you save too much, you’re not maximizing your money’s potential for growth by investing it. Most experts agree that you should save between three and six months of expenses in case you were to lose your job. Loss of income is one of the most common reasons to use an emergency fund, so this rule of thumb makes sense if you assume you’ll be looking for work for three to six months. When determining how much to save, consider your individual circumstances:

• How many streams of income do you rely on? If you have multiple jobs or have a working spouse, you don’t have to save as much money because the likelihood of losing more than one income stream at once is low. 

• What kind of income do you rely on? If you and/or your spouse relies solely on commission or freelance pay, your situation is more precarious and you should consider building a larger emergency fund. 

• Can you predict any big expenses in the near future?If you have an older car or appliances that may need to be replaced soon, it’s probably a good idea to start saving now. The same goes for major home repairs or starting a family. 

Where to Keep Your Savings

A savings account at your local bank is a good place to start. You may also consider an online bank for added security, increased interest rates and less accessibility. You want your emergency account to be accessible in an emergency, but not so accessible that you are constantly tempted to use it. If you know you don’t have very strong willpower, you might not want to have a debit card or checkbook tied to your emergency fund account. Another option is a money market account or CDs, but make sure your funds are liquid enough in case you need to use them.

Many people decide to forgo building an emergency account in favor of saving for retirement. You can technically borrow money from a tax-sheltered account such as a 401(k) or IRA, but you could be faced with steep fines or have to repay it right away. Withdrawing early from a retirement account is not advised because of how much you’ll lose in taxes and fees. You could also rely on credit cards or a home equity line of credit, but this can put you deep in debt if you face a particularly expensive emergency.

Why It’s Important

Think of your emergency fund as self-insurance. You probably have insurance on your car, home and health, among other things. There are certain occurrences that you can’t insure against, such as losing your job. That’s where the emergency account comes in. Rather than relying on consumer debt with high interest rates, which can be especially bad for those who are struggling to become debt free, you can pay for emergency expenses from your savings. Additionally, you won’t have to halt debt repayment during a crisis because you won’t be taking funds from your monthly budget to pay for your emergency. You can’t predict what kinds of emergencies you’re going to face, and you can’t predict when they’ll happen. You can predict that there will most likely be an emergency at some point, and you can prepare in advance by building an adequate emergency fund.

Take the first step toward achieving your goals.

Learn More: Building Your Nest Egg: 401(k) Explained

Do you have a 401(k) savings plan? Do you know how it fits in to your retirement plan? Read on to learn how to use it for your future.