Imagine that you are home one day during a spring storm. It has been pouring for a few hours, so you decide to pass the time binge-watching your favorite television show or curled up with a good novel. You eventually get up from the couch to mill about the house, only to realize that your basem*nt is filled with ankle-high water. Just like that, your day is turned upside down and an innocent rain storm has now transformed into an expensive and lengthy home repair process. This situation is more common than you might think, especially in the spring and summer months.
A flooded basem*nt is undoubtedly a pricey hassle, but being prepared by maintaining a fully stocked emergency fund can help to mitigate the overall strain on your bank accounts. As a financial advisor, clients often ask me how to establish, build and maintain an emergency fund.
Here are a few things to keep in mind:
The Basics
An emergency fund is essentially a savings account specifically reserved for unexpected events and emergencies such as a flooded basem*nt, a car accident, emergency surgery or a sudden loss of income. Once established, it’s the responsibility of the account holder to stock the emergency fund over time. Most experts generally recommend having an emergency fund that can sustain living expenses for three to six months, but you can never truly have enough.
Establishing an emergency fund can be difficult because money that would otherwise be used on groceries, bills or new clothes must instead be put away for future use. Additionally, many people think that they will never be the victim of an emergency or that they will be able to handle any unexpected circ*mstances. However, it’s not that simple. An emergency or unexpected event can have a large, and often times negative, impact on your financial portfolio if you are not prepared.
Building and Maintaining
There are many different ways to build your emergency fund. Setting up automatic contributions from your paycheck or primary bank account is a popular strategy. This way, you avoid having to think about it each month. Choosing to allocate unexpected income, such as a work bonus or tax refund, toward an emergency fund is also a prudent idea. Remember, any extra money allocated is money that does not have to come from other critical areas. Although there is no right or wrong way to build an emergency fund, remaining consistent with contributions is key.
Maintaining the account is arguably the most difficult part of the process. It is important to remain disciplined and only utilize the money for emergencies. Resist the temptation to withdraw for usage in other areas. This will only hinder the progress you’ve made and decrease your level of financial preparedness.
The Benefits
An emergency fund is your safety netin the event of an unexpected crisis. It can help protect your finances, as well as expedite the recovery process. While every situation is different, having money specifically set aside for emergencies helps ensure that you can carry on with your day-to-day life while a remedy is sought.
Additionally, an emergency fund can help preserve other areas of your portfolio. If, for example, you are not financially prepared for an emergency, money originally reserved for college savings, charitable donations, or even big-ticket items such as a new house or car might need to be reallocated to cover the cost of the emergency. Essentially, an emergency fund provides an important buffer of cash for you to pull from before turning to other accounts or assets.
Whether your emergency fund is recently established or stocked with a sizable contribution built over time, having a safety net can help to provide an important and refreshing peace of mind.
Barbara Finder is a Senior Vice President and Financial Advisor with the Wealth Management Division of Morgan Stanley in Chicago. The information contained in this column is not a solicitation to purchase or sell investments.Any information presented is generalin nature and notintended to provide individually tailored investment advice.The strategies and/or investments referencedmay not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circ*mstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author andmay not necessarily reflect the views ofMorgan Stanley Wealth Management, or its affiliates.Morgan Stanley Smith Barney, LLC, member SIPC
FAQs
An emergency fund is a cash reserve that's specifically set aside for unplanned expenses or financial emergencies. Some common examples include car repairs, home repairs, medical bills, or a loss of income.
Why are emergency funds important ___? ›
An emergency fund is a dedicated savings account that's set aside for the proverbial rainy day, intended to cover unexpected costs that may pop up over time. This fund can be used to cover everything from unplanned car repairs to sudden medical expenses.
Why might a person need an emergency fund Quizlet? ›
The purpose of an emergency fund is to set money aside for unexpected financial emergencies and to provide a sense of financial security.
How much do you think you should have in your emergency fund explain why? ›
While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months' worth of expenses.
What are two characteristics that an emergency fund should have? ›
Emergency funds should typically have three to six months' worth of expenses, although the 2020 economic crisis and lockdown has led some experts to suggest up to one year's worth. Individuals should keep their emergency funds in accounts that are easily accessible and easily liquidated.
What are three questions to ask yourself before you spend your emergency fund? ›
Here are three questions you could ask yourself to help determine whether it's time to use your emergency savings: Is this an unexpected expense? Is it necessary? Is it urgent?
What are the three basic reasons to save? ›
First, we save for an emergency fund. Second, we save for purchases. Third, we save for wealth building. Purchases and wealth building are fun, but we can't do any of that until we cover the basics—the emergency fund.
Should you always have an emergency fund? ›
Ideally, you want to set aside enough emergency cash (typically held in a liquid checking, savings, or money market account) to cover at least six months of living expenses. For small business owners or those employed in highly volatile industries and sectors, a 12-month cushion may be more advisable.
What should be the emergency fund? ›
People in stable jobs are recommended to put away 3-6 months' salary into their emergency fund, whereas people with lower job security are recommended to save 6-12 months' salary. A stable income ensures a consistent and bigger emergency fund. The number of earning members in the family also matters.
Do most people have an emergency fund? ›
Nearly one in four (22%) of U.S. adults have no emergency savings at all, Bankrate found—the second-lowest percentage in 13 years of polling. That's especially bad news given that most Americans would need at least six months of emergency savings to feel comfortable day-to-day.
Fewer than half of Americans, 44%, say they can afford to pay a $1,000 emergency expense from their savings, according to Bankrate's survey of more than 1,000 respondents conducted in December. That is up from 43% in 2023, yet level when compared to 2022.
Do 90% of millionaires make over $100,000 a year? ›
Choose the right career
And one crucial detail to note: Millionaire status doesn't equal a sky-high salary. “Only 31% averaged $100,000 a year over the course of their career,” the study found, “and one-third never made six figures in any single working year of their career.”
What if I don't have an emergency fund? ›
If you don't have any sort of emergency fund, you might end up having to rack up a large balance on a credit card to cover an unplanned expense. That could leave you owing lots of money in interest. Now ideally, you should aim to have enough money in emergency savings to cover three months of essential expenses.
How much emergency fund is enough? ›
The general rule is to save at least three to six months' worth of expenses for your emergency fund. This is just a guide amount and a good starting point for most individuals.
How much is too much emergency fund? ›
Your emergency fund could be too big if it exceeds three to six months' worth of expenses. That said, everyone has a different financial picture. Some people keep up to a year's worth of savings in an emergency fund, while others might find that sticking to closer to three months frees them up to pursue other goals.
Why does a student need an emergency fund? ›
An emergency fund is money you've set aside in a separate savings account to help you cover unexpected and urgent expenses in college. Establishing an emergency fund while you're young can help you better prepare for financial challenges and obligations you may face later on in life.
Should I have a 3 or 6 month emergency fund? ›
How much emergency fund should I have? Sudden car repairs, medical emergencies or job loss can all lead to unexpected debt if you're not prepared. It's difficult to predict how much these or other emergencies could cost — but three to six months' worth of expenses is a good goal.
What happens if you don't have an emergency fund? ›
For those without any kind of safety net, paying for unanticipated expenses can mean borrowing money at astronomical interest rates, as well as forking over late fees if you can't make payments on time.
What is an emergency fund not used for? ›
DO understand what constitutes an emergency. Job loss or unexpected expenses requiring travel, car repairs, medical or dental procedures. Things like gifts, entertainment, vacations and sporting events don't qualify.
