How Emergency Funds WorkMay 22, 2023 8:11 am
from our partnership with HerMoney/Filene
If you depleted your emergency fund in the last year or so, don’t panic. We build up emergency funds so they’re there for us when we need them. And if you’ve never had an emergency fund, you absolutely need one to protect yourself if something unexpected happens. Because inevitably, it will.
Here’s what you need to know about the care and feeding of your oh-so-important emergency fund.
How Much Money Is Enough?
Plan on ultimately keeping three to six months’ worth of living expenses in reserve. Dual income families can try for closer to three months of cushion (figuring one earner can back the other earner up in case of a job loss or illness) while one-income families should have closer to six months (because there isn’t another earner to take over).
And, if you’re not close to that yet, don’t panic. Recent research from the JP Morgan Chase Institute suggests you may not need that much. In analyzing 6 million customer accounts, they found that every 5.5 years, account holders experienced an income dip at the same time they had an expenditure spike — which forced them to tap into whatever emergency fund they had on hand. To weather these unfortunate events, people needed about six weeks’ worth of take-home income.
And remember, in an emergency situation, you won’t be spending on extras — rather just the essentials, like rent or a mortgage, food, insurance premiums and gas to get to and from work… That premium cable, salon visit or restaurant meal? Not so much.
Where Do You Keep Your Emergency Fund Money?
It’s best to stash the money in a separate high-yield savings account at your credit union, bank or other financial institution. Why? Because having money close by (but not too close) helps prevent you from reaching for it in your everyday life. That way it’ll be there if your car is in a fender bender or your high-deductible health insurance leaves you with an ER bill you can’t swing. In this way, you can think of your emergency fund like insurance against credit card debt. If you have cash on hand, you can pay for unexpected expenses without going deeper into debt by using a credit card or taking out a high-interest personal loan.
A word about those high yield savings accounts: The variance between APY (annual percentage yield) offered from financial institution to financial institution can differ dramatically — the average interest rate on a plain vanilla bank savings account is still way under 1%, you can easily get four times that by shopping around. And, thanks to the rising interest rate environment, the rates at credit unions (which tend to be competitive in these markets) are likely to keep on rising. When you’re saving and earning interest that goes back into your account, the amount can compound quickly with a higher rate. That’s a good thing.
How Do You Build (Or Replenish) Your Emergency Stash?
Here are a few ideas: Three times each year, on average, people experience an income spike. These tend to group around the end of the calendar year and the beginning of the next, and can be things like bonuses, extra hours for additional holiday shifts, and tax refunds. The key here is saving more during the times when we have additional money coming in, which will allow us to hit “pause” on saving (or save less) when our income dips.
Make use of months that contain a fifth Friday. Some 80% of families have a job that pays on a weekly or biweekly basis, and often on Fridays. Four months in the calendar year have five Fridays instead of four (which means you’ll get three paychecks instead of two). Why not put a chunk of that third paycheck into savings?
Do you get a hefty tax refund each year? If so, changing your withholding to be more in line with what you actually owe Uncle Sam could pad your paycheck. (Because while a fat refund check can feel good when it arrives, what’s even better is using that money throughout the year to build up your emergency fund.) Do yourself a favor and set up an automatic transfer of funds to go directly into your emergency account on the day your paycheck lands. That way you won’t be tempted to spend it.
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