“emergency funds” is money that can be used in financial distress. An emergency fund’s purpose is to provide financial security and a safety net for unanticipated expenses such as major home repairs or illness.
An emergency fund typically has cash or other liquid assets. This allows you to avoid the temptation of taking out high-interest debts, such as credit cards and unsecured loans, but also helps you protect your future by investing in retirement funds.
Understanding Emergency Funds
When you save money for financial hardship, an emergency fund is created. This could include losing your job, suffering from a debilitating condition, major repairs to your house or car, as well as the type of economic crisis or lockdown that occurred in 2020.
Your financial situation, your lifestyle, debts, and financial status will all influence the size of your emergency fund. Financial advisors often recommend that you save enough money to cover three to six months of expenses. This can help you to weather a small healthcare bill or short spell of unemployment.
Some experts recommend a larger cushion. Suze Orman (celebrity finance expert) suggests that an emergency fund can cover up to eight months worth of outlays. She made this claim well before the 2020 crisis. It is a stark reminder of just how severe and sudden an economic slump can be.
Your individual circumstances will determine the savings level you are comfortable with. For example, a single adult may be content to pay three months’ worth of expenses while the sole breadwinner of a family might want enough to cover half of a year.5 However, research shows that many Americans fall far short of this recommended savings level. A 2020 Federal Reserve survey found that nearly one-fourth of Americans lack the cash or equivalent to pay $400 in expenses. This figure was 45% for unemployed workers.
You might be able to set modest goals if you live paycheck to paycheck. For example, you could start by putting 2% of your income into a savings account and gradually increasing your contributions rate each month. A modest safety net can save you some time in the event of an unexpected financial emergency.