Understanding Emergency Funds: What They Are and How to Use Them

An emergency fund is an essential part of a strong financial plan. You might think you don’t need one, but without one, you leave yourself at risk.

What is an Emergency Fund?

An emergency fund is a dedicated fund of money set aside to cover unexpected expenses or financial emergencies, such as unexpected medical bills, car repairs, home repairs or job loss.

Think of an emergency fund as your financial buffer, designed to keep you afloat during unforeseen circumstances. An emergency fund is not for something you could have predicted like new winter tires, a vacation or home renovations.

The primary goal of an emergency fund is to provide you with peace of mind and financial stability, ensuring you don't have to rely on debt when the unexpected occurs.

Why You Need an Emergency Fund

Financial Security: An emergency fund acts as a financial safety net, helping you navigate through tough times without derailing your money goals.

Avoiding Debt: By having readily accessible funds specifically for emergencies, you can avoid accumulating debt to pay for unexpected expenses.

Reducing Stress: Knowing you have a cushion to fall back on will significantly reduce financial anxiety and stress.

How to Build an Emergency Fund

Set a Realistic Goal

A typical emergency fund should be three to six months' worth of living expenses (not income). This amount can vary based on your personal circumstances, such as job security, number of dependents or whether you have a dual income household. If you have higher job security or your spouse has a full time job, you might be closer to three months of expenses. If you work on commission, six months will be more comfortable.

Start Small and Build Gradually

If saving several months of expenses seems too difficult, start with a smaller, more manageable goal, like $1,000 and gradually increase your target.

Apply Anything Extra in Your Budget

To do this, you first need to make a budget (find out how here) and record all of your income and expenses. Once you know your income, and your necessary expenses, anything extra can be applied towards your emergency fund. Try our free Simple Starter Budget resource!

Use Extra Income to Get There Quicker

If you have any extra income, for example, a tax refund, a bonus at work, overtime pay, gift money or you sell something, add it to your emergency fund to reach your goal quicker.

Choose the Right Account

Your emergency fund is not an investment. Think of it more like an insurance policy. Keep your emergency fund in a separate, easily accessible account, such as a high interest/yield savings account. This way, it's separate from your everyday spending money so you don’t accidentally dip into it, but still easily accessible in an emergency.

Using Your Emergency Fund

Assess the Situation: When a situation comes up, evaluate whether it is truly an emergency and if the need to spend money on it is necessary or urgent. If it is not, make a plan to save for this expense.

Cover the Only Expense: Once you've determined that an expense qualifies as an emergency, withdraw only the necessary amount from your emergency fund to cover it.

Replenish Your Fund: After you use any or all of your emergency fund, it’s important to prioritize replenishing it. 

Tips for Maintaining Your Emergency Fund

Regular Contributions: Even after reaching your goal, it’s a good idea to continue to contribute regularly even if just by a small amount. This will help you keep pace with inflation and any increasing expenses.

Periodic Reviews: It’s important to periodically review your emergency fund to ensure it still aligns with your financial situation. Adjust your target amount if necessary.

Avoid Non-Emergency Use: Resist the temptation to use your emergency fund for non-emergency expenses. Its purpose is to provide a financial buffer in times of true need.

An emergency fund is a key component of a good financial plan. It offers the security and peace of mind needed to handle life's unexpected challenges without compromising your financial future. By setting realistic goals, applying extra funds, and using the fund wisely, you can build a solid safety net that keeps you prepared for whatever comes your way.

Try our FREE Simple Starter Budget resource to find money in your budget to apply towards your emergency fund.