Why You Need an Emergency Fund

Also known as a rainy-day fund, the money in this savings account will tide you over in case you lose your income or have a major expense come up.

By Niko Vercelletto October 19, 2020

Think about this: If your family had an emergency that required a large amount of money—unexpected car repairs, job loss, or major medical expense—would you have enough cash on hand to pay it? If you’re like most Americans, you would probably have a difficult time coming up with the money without selling something or taking out a loan.

More than half of all Americans have less than $1,000 saved, according to a GoBankingRates survey in 2017. Even scarier, 39 percent have no savings at all. With the average household spending of $60,000 in 2017, many aren’t even saving enough for weekly grocery bills, let alone car repairs and doctors’ visits.

What’s causing this inability to save? There are many reasons, but the three biggest are high-cost of living, low salaries, and high debt balances, specifically from college and credit cards. With a bachelor’s degree from a private university costing an average of $43,000 per year and the average adult racking up almost $7,000 in credit-card debt, it’s no wonder many aren’t saving.

Even if there were no barriers to saving, banks aren’t exactly enticing customers to deposit money. The average interest rate on a savings account is a measly 0.01% (this means that for every $1,000 you put in, you receive $10 per year), with many of the major banks offering even less in terms of interest.

Yet despite the negativity surrounding savings rates and accounts in America, creating an emergency fund is one of the most important things you can do for financial stability and peace of mind. One of the biggest reasons you want this fund is in case of job loss. The latter half of 2018 saw 1.8 million people either laid off or discharged per month, according to the Bureau of Labor Statistics. There is no way to know if, and when, a major change will occur, but an emergency fund can soften the blow.

“Life happens and will happen,” says Todd Christensen, education manager at MoneyFit, a nonprofit based on Long Island that helps with debt and credit counseling. “[Things will go wrong] whether you are saving or not. Having an emergency fund just makes it less stressful.”

Choose an Emergency Fund Account

First, you need a place to save your money. The most important rule in choosing an account to deposit your funds is to make sure it’s easily accessible. This means do not invest your emergency fund into stocks, bonds, IRAs, or 401Ks, basically anything that is volatile in value; you don’t want to be cashing in bonds to pay for a trip to the emergency room.

The most common choices are Federal Deposit Insurance Corporation (FDIC)-insured savings or checking accounts or a combination of both. This means that if your bank goes out of business or loses your money, you are protected against that loss. Banks are not mandated to be FDIC-insured, but it’s become a point of competition among many. Simply go online or call the bank you’re interested in for more information.

Another thing to consider is interest. Despite the aforementioned terrible rates, not all accounts are created equal; there are banks that offer upwards of 2.0 percent. While you will need to do your own research, some safe bets are FNBO Direct (2.15 percent), CIT Bank (1.55 percent), and American Express Bank (2.10 percent).

Lastly, look for accounts that have no or low minimum balances, as well as ones that do not have annual or monthly fees. Some banks charge you simply for the privilege of opening a savings account; paying $10 every month can quickly suck up your savings.

“I am no fan of accounts with fees,” Christensen says. “I recommend having…a savings account at a bank or credit union separate from where you have your checking account [so] you are not tempted to transfer money…for nonessential expenses.”

How Much Should Be in My Emergency Fund?

The short answer, and general rule of thumb, is six months’ worth of expenses. The long answer? It depends on a number of factors, including how much debt you have and the stability of your income.

A larger emergency fund (nine to 12 months) may be warranted if your income is variable or uncertain, such as freelance or travel work. However, no matter what your goal, you want to commit. “Too many parents are worried that they won’t be able to save the ten to fifteen percent of their income many experts recommend, so they do not even start,” Christensen says. “Initially, committing to save something (even five dollars) is more important than the amount you are saving.”

The foundation of financial well-being is knowing what you’re spending your money on. If you don’t know how much you spend per month, you’ll need to create a budget and reduce expenses. Minimizing your expenses to practical necessities (housing costs, utilities, food), which are harder to get rid of than entertainment items (you don’t need both Netflix and Hulu, we promise), will bring more money in your pocket and, eventually, in your emergency fund.

Michele Lee, a registered representative of Guardian Life Insurance in Jericho, has tips for cutting expenses. “[First], examine current bills. See where the money is going and think of cutting out extras and finding cheaper alternatives. [Next], pay with cash. There's something about the tactile quality of cash that makes it hard to part with. [Finally], adjust your habits. All of us have habits that we fall into that can be revised and made more financially healthy,” she says.

Make a list of recurring purchases that happen every month, such as gas, mortgage or rent payments, and child care, and tally the total. There are free online tools to make this easier, such as Mint.com and PersonalCapital.com, which link to your bank account and automatically categorize your purchases. You can even create email and text alerts that will tell you when you have exceeded your set limit.

If you have debts with interest rates that are higher than 10 percent, you should “focus the bulk of your discretionary cash on paying down your debts,” Christensen advises. “But still contribute something—even five or twenty-five dollars a month. …If you can’t save while repaying your debts, you won’t save after your debts are paid off.”

Figuring how to create an emergency fund can be scary; after all, the word “emergency” is in the name. However, the benefits of having one—financial, emotional, mental—all outweigh the slight headache that comes with budgeting and saving. Simply having an emergency fund will put you ahead of the majority of the country, but, even more important, it will put you ahead in your own life.

Get into the Saving Mindset

Now comes the fun part: depositing the money and watching your savings grow. There are numerous ways to get funds into your emergency account, many you will find as you experiment, but here are three easy things you can do.

Create a Recurring Direct Deposit

The best way to save is when you don’t even think about it. Almost all banks will have an option online that lets you set up recurring payments from your checking account into your savings and vice versa. On the date you choose once a month, any amount of money can be automatically deposited into your fund without you having to lift a finger. Trust us, you won’t even notice it’s happening.

Even better is to have the money taken straight out of your paycheck. “Most employers offer two or more direct deposits,” Christensen says. “Set up a deposit to your savings so you do not even see it in your paycheck.”

Setup a Change Jar

A change jar is the one thing everyone should have, yet no one does. Whenever you get extra change, put it straight into the jar. While putting in 15 cents every couple of days doesn’t seem like a lot, it adds up over time. Just 1 pound of quarters equals $20; imagine how much money you could have by simply storing your change over a few months.

Recruit a Savings Buddy

Behind religion and politics, money is seen as a rude topic to discuss among family and friends. However, when it comes to your saving goals, having a ‘savings buddy’ can help dramatically because it gets you accustomed to talking about saving, as well as keeping the idea of gathering funds in the forefront of your mind. It also creates a competitive edge; both of you can set a savings goal and see who achieves it first.