An emergency fund can protect you from some serious panic when life gives you lemons, but many Americans aren’t saving that kind of cash. Last year, a Federal Reserve study found that nearly half of U.S. households would have a hard time paying an unexpected $400 bill. If you’re part of that group, you’ll face some tough choices the next time your car breaks down or you land in the emergency room.
While saving any amount of money is a step in the right direction, you can optimize your finances with a bit of strategy. Here’s how to get started.
Step One: Build an Emergency Fund
Your first savings goal should be building an emergency fund to cushion the blow of bad fortune. But having a cushion isn’t the only benefit of keeping an emergency fund.
Avoid debt: Credit cards are a tempting solution to short-term cash flow problems, but borrowing on plastic is expensive. Credit cards often charge interest rates above 20 percent. If you put $1,000 on your card at 20 percent, it will take more than six years of minimum payments to eliminate that debt—and you’ll pay $560.53 in interest alone. Your emergency fund can help you cover unexpected expenses without taking on toxic debt.
Get through lean times: If you lose your job or can’t work, you’ll still need to pay for necessities like rent and health insurance premiums. An emergency fund helps avoid drastic measures while you recover from injury or find another job. It’s easy to believe unemployment benefits will keep you afloat, but you’ll probably get less than you hoped. For example, Texas residents receive a maximum benefit of $493 per week ($1,972 per month), but the average young family in most Texas towns spends between $4,500 to $6,250 per month—leaving at least a $2,528 gap between actual spending and unemployment benefits.
Protect your financial future: Yes, if you hit a financial rough patch, you could stop paying your student loans or raid your retirement account. But the consequences aren’t worth it. You’ll need to repay those loans eventually, and penalty charges (plus additional interest) will increase the amount you must pay. Your credit will suffer if you stop making payments, which could affect loan availability and terms for years to come. Making early withdrawals from retirement funds not only steals from your golden years, you’ll likely have to pay painful penalty taxes. With an emergency fund, you’re in a better position to deal without making things worse.
How Much do You Need?
Your emergency fund goal should be the equivalent of three months of living expenses. If you want to be safe, you can save more, but don’t overdo it. Keeping too much in your emergency fund prevents you from putting money toward other goals and investing for growth. Decide how much risk you’re willing to take, and evaluate your situation: Would it be easy to cut your spending and find a different income source quickly, or do you want an extra-cushy safety net?
It’s ok to start small. The most important thing is that you start. Pick a goal—$1,000, for example—that’s small enough to reach, but big enough to make a difference and then build on your success. Over a year, contributing $20 per week will build to more than $1,000 in a savings account.
Step Two: Find the Best Place to Stash Your Cash
When it comes to finding the best place to keep your emergency and savings funds, finding an account that will earn the most bang for your buck is key. Don’t overlook restrictions in favor of a higher interest rate, though, those restrictions might outweigh the benefits of opening the account.
Don’t be afraid to open multiple accounts either—as long as you’re not taking too much in monthly fees. Different banks (and accounts) excel in different areas, and it’s wise to put your money where it serves you best. Look for the one that works best for your situation.
Here’s a brief overview of the most common savings vehicles to get you started:
CDs (Certificates of Deposit)
CDs allow you to deposit a lump sum and earn a set amount of interest over time. Typically, the longer you can sock the money away, the more interest you’ll make, but early withdrawals will cost you.
Good For: People who already have an emergency fund set aside and are looking to make a guaranteed rate of return on a chunk of change they won’t need to access in the near future.
- Rates lock in, which is a great feature when interest rates are high.
- If you can commit to a longer term (60 months or more), CDs offer higher yields than savings accounts or money market accounts.
- You can’t withdraw money early without a penalty.
- Your interest rates will stay the same, even if rates increase while you’re locked in.
- 6 month: 0.16 percent
- 12 month: 0.27 percent
- 60 month: 0.86 percent
Money Market Accounts
These accounts fall somewhere between checking accounts and CDs. You’ll earn interest on your daily balance—based on money market trends—and receive a debit card or checkbook to make withdrawals.
Good For: People who already have an emergency fund in a savings account and are looking for an interest-bearing account to stash additional savings (and who can meet the minimum balance requirements.)
- More liquid than CDs.
- Most offer check writing, and many offer checking deposit-like features such as ATM/debit cards and mobile check deposit.
- Typically limited to six withdrawals per month, not counting ATM withdrawals.
- Minimum account opening requirements of $1,000 and up, generally.
- Most require a minimum balance to avoid monthly maintenance fees.
- 0.08 percent on average for a $10,000 deposit
- 1.25 percent on the high end for a $10,000 deposit
- 0.01 percent on the low end for a $10,000 deposit
High Interest Checking Accounts
Like the name suggests, this is an interest-bearing checking account that works like your typical checking account, with debit/ATM cards and checks to make purchases/withdrawals.
Good For: People who can meet the minimum opening deposit requirement and keep up with the monthly (and daily) requirements to maximize the full benefits of the account.
- Higher interest than basic savings, with less withdrawal restrictions.
- Interest is calculated by considering the daily average balance, which can make for different yields than you expected.
- Most banks require minimum opening deposits ranging from $1,000 to $25,000 and up.
- Some banks require customers to maintain a minimum daily balance.
- May require a minimum number of withdrawals from the account each month.
- May have monthly maintenance and other fees.
- 0.5 percent on average
- 0.01 percent on the low end
- 1.5 percent on the high end
Savings accounts are safer than storing cash under your mattress and almost as easy to set up, but they don’t offer much in the way of interest yields. These accounts are available from practically every consumer bank, with online offerings generally giving customers better interest rates than those found at major brick-and-mortar chains.
Good For: People just starting to save for their emergency savings account. It’s easy to direct deposit a portion of your paycheck into the account, but just hard enough to take money out of it, prioritizing contributions over withdrawals.
- Easy to set up and maintain
- Option to link directly to your checking for overdraft protection
- Easy to set up automatic transfers
- Low opening deposit requirements
- Limited to six withdrawals a month (not counting ATM withdrawals)
- May have monthly maintenance fees and other non-obvious charges like a wire-transfer fee for moving funds
- May require minimum account balance
- 0.06 percent on average
- 1.10 percent on the high end
- 0.05 on the low end
Step Three: Make Saving Easy
It takes discipline to save money, and life often derails our best intentions. Fortunately, there are ways to make saving effortless.
Pay yourself first: Make saving a priority. When people fail to save, it’s often because they save what’s left after all their other monthly spending. Move savings up to the top of the list, and it’s more likely to happen. Add a budget category for savings, and treat it like the electricity bill. It must get “paid” every month.
Automate your savings: To ensure you make progress toward your goals, get that money out of your checking account before you spend it. Set up automatic monthly transfers from your checking account to your savings account around the time you get paid or, better yet, have your employer direct deposit a portion of your pay into a dedicated savings account.
Step Four: Jump Start Your Savings
Saving three months’ worth of expenses can be an intimidating goal. Again, the most important thing is that you start, and there are several ways to give your account balance a quick boost.
Sell stuff: We all have items sitting around that we don’t need or use—and they’re probably worth money. Just make sure you weigh potential profits against the time it takes to sell the item to make sure you’re really benefiting.
Go big: Create some space in your monthly budget with one or two big “wins.” For example, cutting out cable TV saves $103 a month on average.
Eliminate leaks in your spending: Little things add up, so scrutinize your monthly statements for repeat offenders. For example, buying lunch at work might cost less than $10 per day, but that adds up to more than $200 each month. Try brown-bagging instead.
Windfalls: If you get unexpected cash (a generous gift or tax refund, for example), save that money instead of treating yourself. Think of it as a “reverse emergency.”
Step Five: Build on Your Success
Eventually, you’ll have a healthy emergency fund in place. Once you do, put those stellar saving habits you developed to use for other purposes.
There are countless goals to save for—you’ll need to decide which ones to prioritize. For example, would you like to stop working someday? If so, start saving for retirement. Want to buy a home or a new vehicle at some point? It will be easier to qualify—and less expensive to borrow—if you build up a nice down payment.
Even if you don’t know exactly what you’re saving for, it’s still a good practice. Keep some money in a “whatever” fund, and you’ll have a head start on goals (or extremely big surprises) that come up later in life.