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The Importance of Emergency Funds and How To Build One

January 31, 2023
Read the importance of emergency funds and how to build one

The only certain thing in this life is uncertainty. Financial surprises happen to all of us, which is why building an emergency fund is so important. Emergency funds should be in a high-interest savings account with a higher APY than a typical savings account, making it a better option for long-term asset storage.

What Is an Emergency Fund?

While your regular savings account might have money that can be transferred to your checking account on a whim, the assets in an emergency fund should be used as a last resort. If the only other choice is to go into the red or fall into credit card debt, that’s when you’ll be relieved to have your emergency fund as a buffer.

Why Is it Important to Have an Emergency Fund?

Emergency funds act like a buffer, preventing you from falling into debt should a large, surprise expense come along. These funds can also come into play should you lose your main source of income. This is why experts suggest saving the equivalent of three to six months of expenses in an emergency fund.

A broken-down car or an unexpected medical crisis can easily send individuals into a cycle of mounting debt. An emergency fund can prevent that from happening.

Don’t overlook the peace of mind an emergency fund can provide you. Nothing is ever certain, so emergency funds can give you confidence in case of a surprise lay-off or medical bill. The best part? Starting an emergency fund doesn’t have to be complicated or costly and can be started today!

How to Start an Emergency Fund

If you’re interested in starting an emergency fund, there are a few steps to take before you start allocating funds. First, you’ll want to figure out how much money you can put away monthly. Remember to keep your goal in mind. You’re shooting for three to six months of expenses. Then you’re ready to get started by choosing a savings vehicle, setting a goal and setting up your contributions. Find out more about how to build an emergency fund by reading each step below.

1. Assess Your Financial Situation

Taking stock of your financial situation is an important step in setting up an emergency fund that will help you in a crisis. Don’t overlook these important steps while planning your fund.

  • Calculate your monthly expenses: Know how much your lifestyle costs. Build a basic budget so that you’ll know how much you need to save should you lose your income for three to six months.
  • Identify potential financial risks: Is your car having issues and threatening to break down? Are there talks of layoffs around the office? These aren’t pleasant things to talk about but they’re important to take into consideration when building your emergency fund to know how aggressively you should save and how much you should put in your fund.
  • Determining the ideal emergency fund size: You’ll want to build up three to six months of expenses. Expense calculations should include the cost of your rent or mortgage, your energy bill, grocery costs, insurance and any other recurring essential expenses.

2. Build Your Emergency Fund

Now that you better understand your financial situation, you’ll know how much to save and how much you can set aside every month. Here are a few considerations while building your emergency fund.

  •  Choosing the right account: Choose a separate account from your savings and checking account to ensure that you can keep track of your emergency fund. It should have a high enough interest rate to keep up with inflation as the goal is to have your funds in this account long term.
  • Automating fund contributions: Set up automatic transfers from your checking to ensure that your emergency fund will grow at a steady, trackable pace.

Determine Where to Keep an Emergency Fund

There’s a reason saving cash under a mattress isn’t recommended. When you’re saving long-term, it’s important to choose a savings vehicle that has a high enough interest rate that will keep up with inflation rates. Below are a few savings options you can consider for emergency savings.

  • High-yield savings accounts: High-yield savings accounts offer a much higher annual percentage yield (APY) than a typical savings account. You can transfer money in and out of this account freely. There’s no fee or minimum balance to start a high-yield savings account, making this an accessible savings vehicle for people of all incomes and walks of life.
  • Money market accounts: A money market account offers tiered dividends that let you earn more when your balance is higher. While the interest rate in a money market account may be low right now, it’s a good way to invest your money while keeping it liquid in case of emergency.
  • Certificates of deposit: Certificates of deposits (CDs) often earn a higher interest rate than a high-yield savings account but they’re less liquid than the previous two options. You can access the funds in a CD after the certificate term is over. Usually, that’s three to sixty months. Most CDs can be accessed before the term is through with a penalty fee. When choosing a CD for an emergency fund, check that the term is shorter so that you can access it without having to pay for your money.

Need help deciding how to save? As a non-profit credit union, DCU is all about educating members for better financial health. See if membership is right for you and get a little extra guidance on your saving journey.

3. Start Your Emergency Fund: Finding the Money

We can say it’s simple to open a savings account, but finding the money to set aside can be tough, especially if you’re already in debt. However, the long-term benefits of having an emergency fund will be worth it the next time you hit a fiscal hurdle. Here are a few tips to help you find a little extra cash to put away for your fund.

  • Cut spending: Take a hard look at your monthly expenses. Can you start making coffee at home, even on Fridays? Can you cut streaming services or switch to a less expensive phone service provider? There are a lot of creative ways to cut expenses and make saving a little simpler.
  • Increase your income streams: Is there a hobby you already have that could make you money? Could you set aside time on the weekends to drive for a rideshare app? Make food deliveries? How about watching your neighbor’s kid after school or their dog when they’re gone on the weekends? All of these options won’t necessarily pay the bills but they will help you meet your emergency fund goals.
  • Redirect windfalls and bonuses: It’s tempting to do something splashy when you get that holiday bonus, but putting it in your emergency fund is not only a practical move, it’s gratifying. Reframe the term “treat yourself” and enjoy the relief and pride that comes with watching your emergency fund grow.

4. Manage and Monitor Your Fund

When you’re building your fund, you’ll want to regularly check in. If you’re automatically transferring funds, this practice will make sure the transfers are occurring as they should.

Even if you’ve reached your financial goal and your emergency fund is where you need it to be, you don’t want to forget about it. Revisit your financial situation. Maybe you have a growing family and need to account for more dependents. Maybe you got a raise and can afford to put more money away — shoot for six months rather than three. There are plenty of reasons to reassess how much money to keep in your emergency fund.

Start Your Emergency Fund with DCU

Having an emergency fund can change your whole financial future. This fund can protect you from falling into debt or help you stay current on mortgage or rent payments in times of fiscal strife. There’s no better time to start taking steps toward getting started than here and now.

DCU is always there for members, happily providing guidance on fiscal planning. Learn more about becoming a DCU member. There, you can find guidance as well as a high-yield savings account, money market account or a CD to get your emergency fund started.

Please note, membership is required to open a DCU savings account. Visit our membership eligibility page for more information.

This article is for informational purposes only. It is not intended to serve as legal, financial, investment or tax advice or indicate that a specific DCU product or service is right for you. For specific advice about your unique circumstances, you may wish to consult a financial professional.

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