Why Emergency Funds Are a Financial Lifesaver
Life rarely follows a predictable script. One day is a postcard-perfect scene; the next, bang, you have a medical bill, a car repair, or job loss coming out of nowhere. These situations highlight why having emergency funds is not just a financial luxury but a crucial necessity. However, according to a 2023 Bankrate survey, 57% of Americans cannot find any way to cover a $1,000 emergency expense without going into debt.
What exactly is an emergency fund? And why is it important? Most importantly, how do you set up one that is useful to you and your family? That’s what we are going to explore.
What Are Emergency Funds?
If you fall short on your savings while managing any kind of emergency, you might have to depend on high-interest credit cards or personal loans, which can worsen your financial stress. This cycle of borrowing and repaying can create a long-term burden that many find difficult to escape.
Emergency funds are a savings reserve created for you to cover unforeseen expenses or financial emergencies. It offers you peace of mind, allowing you to face sudden expenses without the anxiety of needing to borrow money and piling up debt. Without such savings, even small setbacks can escalate into significant financial challenges. Therefore, emergency funds gives you the confidence that you can handle unfortunate circumstances without compromising your financial stability.
The Stark Reality: Are You Prepared?
Recent research highlights a troubling trend regarding emergency savings:
-
The 2023 Study on Low-Income Families:
A study by the Urban Institute focused specifically on families with children revealed that more than two-thirds (68.5 percent) of low-income parents living with children under age 19 reported problems paying for housing, utilities, food, or medical care.
-
LMU Newsroom Report on Emergency funds:
According to the LMU Newsroom, only 19% of Americans increased their emergency savings in 2023, potentially leaving many households financially vulnerable.
-
Bankrate 2024 Annual Emergency Savings Report:
A Bankrate poll indicates that nearly six in ten (59%) U.S. adults are uncomfortable with their level of emergency savings.
Over 1 in 4 people have no Emergency funds
Keeping at least three months of expenses saved can help you weather a job loss, major unexpected bill or other sudden expense. However, 27 percent of U.S. adults have no emergency savings at all, the highest percentage since Bankrate asked the question in 2020.
Generationally, Americans vary widely in their emergency savings levels. Over 1 in 3 (34 percent) millennials have no emergency funds, the highest percentage of any generation:
- Gen Zers (ages 18-27): 29 percent
- Millennials (ages 28-43): 34 percent
- Gen Xers (ages 44-59): 31 percent
- Baby boomers (ages 60-78): 16 percent
Source: Bankrate
Determining the Right Amount to Save in Your Emergency Funds
Considering professional recommendations from financial advisors, it’s advised to set aside enough savings to chase the next three to six months down the road. However, given the unpredictability of modern life, particularly amidst economic uncertainties, it is now only wiser to strive for savings that cover up to a year’s worth of living costs, especially for individuals in unstable industries.
Remember, the goal of an emergency fund is not only to cover day-to-day expenses but also to keep you afloat during longer periods of financial uncertainty. If you are the sole breadwinner or work in an industry with limited job security, aiming for a more substantial emergency fund will help safeguard against potential income interruptions.
Optimal Places to Keep Your Emergency Funds
Liquidity and security are the key advantage factors to take into account when deciding upon where to keep your emergency funds. You want an account that is both conveniently accessible and not overly handy to prevent needless withdrawals and unnecessary expenditures. Here are some tried and true choices:
-
High-yield savings accounts or HYSAs:
Accessibility and return are balanced in these accounts. Some of the best high-yield savings accounts in January 2025 offered annual percentage yields (APYs) up to 4.75%, which was significantly higher than that of regular savings accounts. This keeps your emergency funds liquid while allowing them to develop.
Liquidity, or the ability to swiftly access cash in an emergency, is one of the primary advantages of a HYSA. While you won’t earn the highest returns, the interest rate is still enough to make your emergency fund work for you.
-
Money Market Accounts:
These are another popular choice for emergency savings. They typically offer higher interest rates compared to regular savings accounts and also provide check-writing privileges. As of late 2023, many money market accounts offer interest rates in the range of 5% APY, with some of the top accounts reaching as high as 5.35% APY.
Like HYSAs, money market accounts provide a safe, liquid option for keeping your emergency fund. One added benefit is that many accounts allow limited check-writing capabilities, which can be useful in a true emergency situation where you need to pay a bill or expense immediately.
-
Certificates of Deposit (CDs) with Short-Term Maturity:
While not as liquid, if you don’t expect to need immediate access to your emergency fund, short-term CDs can offer competitive interest rates. Ensure that you choose a term length of less than a year, so you’re not locked in when an emergency arises.
While CDs offer a slightly higher return than a savings account, they do come with restrictions. You may face penalties for early withdrawal, which is why they may not be the best option for funds that you may need quickly. However, if you’re confident you won’t need to dip into your emergency savings in the short term, a short-term CD can be a good way to grow your savings.
Strategies to Build Your Emergency Funds
-
Set Clear Goals:
Begin by determining how much you need. A good starting point is $1,000, as many emergencies fall into that range. Once you reach that, aim for a larger target that covers a full month or more of living expenses. -
Automate Savings:
Set up automatic transfers to your emergency fund from your checking account. Even $50 to $100 per paycheck can add up over time. For instance, in one year, $100 bi-weekly could build $2,600 in savings. -
Reduce Unnecessary Spending:
Look for small ways to cut back on discretionary spending. -
Utilize Windfalls:
Rather than spending tax refunds, bonuses, or cash gifts, direct these funds toward your emergency savings. This can make a significant impact over time, allowing you to reach your savings goals more quickly. - Increase Your Income:
Consider exploring side gigs or freelance opportunities to increase your income. According to a 2023 article from Entrepreneur, nearly 50% of Americans have a secondary source of income or side hustle.
Common Challenges and How to Overcome Them
-
“I don’t have enough money to save.”
Even saving $5 or $10 a week can add up. Focus on starting small, and gradually increase your savings amount as you reduce other costs. -
“I keep dipping into my savings.”
Consider keeping your emergency fund in a separate, harder-to-access account. Some banks allow you to open a separate savings account that requires more than just an online transfer to access the money. -
“I don’t know where to start.”
The first step is tracking your expenses. Once you understand your spending patterns, you can identify areas to cut back and reallocate those funds to your savings.
The Bigger Picture
An emergency fund does more than just cover unexpected expenses. It provides financial stability, reduces stress, and allows you to focus on long-term goals like buying a home, saving for retirement, or investing in your children’s education.
Financial experts agree that an emergency fund is the cornerstone of a solid financial plan. Without it, even minor setbacks can derail your progress and force you into debt. But with it, you’re empowered to handle life’s surprises with confidence.
At nVest Advisors, we provide high-yield savings options via our custodian partner, Betterment, to help you in building your emergency funds with competitive interest rates. We additionally offer a variety of other savings and cash-equivalent investments with some of the best interest rates available. Book a meeting with one of our financial experts today, to discover how we can assist you in creating a stable financial base for life’s uncertainties.