What would happen if you received a bill for a $1,000 expense today that you weren’t expecting? Do you have the cash available to pay for it, or would you have to borrow money or dip into credit card debt to cover the cost? If you don’t have the cash available, you’re not alone—61% of Americans don’t have the savings available for a $1,000 emergency expense.1 Having a fully funded emergency savings fund is important—you may avoid taking on debt, using your hard-earned savings, or taking a loan from your retirement savings. Being able to manage costly emergencies is less stressful when you have cash set aside for that purpose.
The percentage of Americans who have enough money for a $1,000 emergency expense
Source: “Survey: Fewer than 4 in 10 Americans could pay a surprise $1,000 bill from savings,” Bankrate, LLC, 1/11/21.
Insurance isn’t an exciting expense to have, but if you get into a fender bender, you’re probably relieved you’ve been paying your insurance premiums on time. Emergency funds are similar by providing that comfort, except you get to keep all the money even if the accident doesn’t happen.
What’s an emergency savings fund?
As the name implies, it’s a fund to save money for when emergencies happen. But let’s specify what it’s not. It’s not for expenses you can expect—even if infrequent—such as:
- New tires on your car
- Maintenance on your hot water heater
- Tax bills
- Paying down your debt
Emergencies should surprise you. Some common examples of financial emergencies2 are:
- Job loss
- Medical emergencies
- A death in the family
- Unforeseen home repairs
Emergency fund versus savings account—what’s the difference?
You may be thinking, “I already have a checking and savings account at my bank—why should I have a separate emergency fund?” Because they all serve slightly different purposes.
Checking account—The purpose of your checking account is to manage your cash flow. Your paychecks get deposited here, and your bills get paid from here, too.
Savings account—Your savings account should be for short-term financial goals, such as:
Your savings account is an accessible place to put your money that earns a minimal rate of interest. Also, you likely have a plan to spend this money within the near future but can’t take the risk of it decreasing in value (e.g., by investing it in stocks).
Emergency fund—Your emergency savings account is a segregated account for the specific purpose of paying for unexpected events. You’ll determine an appropriate amount to put into the fund, create a plan to reach that goal, and, once you reach it, direct the money to other financial goals such as retirement or paying down debt. When a day comes where an emergency happens, you won’t have the added stress of worrying about how it will affect your finances as many people do.3
Having the money set aside in a separate account prevents you from accidentally dipping into your emergency funds when you buy a car or upgrade your phone. Without the separation, you may find yourself without enough cash if an emergency happens and you need the money.
“An emergency fund turns a crisis into an inconvenience. Once I got an emergency fund, I quit having emergencies.”
How to start an emergency savings account
These two steps can help you build the emergency savings you need.
1 Create an emergency savings goal
How much money do you need for emergencies? Experts usually recommend having three to six months’ worth of expenses set aside in an emergency fund.4 That may seem like a lot, but emergencies can be expensive. If you lose your job, you could be out of work for several months, and an unforeseen home repair could mean replacing your entire roof. You may need more or less than this based on your situation:
- Do you have job and income stability?
- Are there medical issues that may trigger large bills?
- How susceptible are you to major crises such as the COVID-19 pandemic?
- Are your ongoing expenses exceptionally low or high?
Ultimately, you decide what makes the most sense for your circumstances.
2 Decide how much to contribute—and get it done
How much, and how often, can you add to your emergency fund? The more money you save, the quicker you’ll reach your goal—and just like with retirement savings, recurring transfers or automatic payroll deductions may be a great way to do it. Once you attain your target, you should repurpose your savings for other financial goals.
Remember, you don’t fund an emergency savings account with a limitless goal like you do with your retirement account—you set a goal and achieve it. Once you get there, you’re done until you need to take the money and replenish it again.
Avoid your next crisis—build an emergency savings fund
Saving for emergencies while juggling all your financial goals isn’t easy. But emergencies happen, and they can be costly, stressful, and disruptive if you’re unprepared. Having cash set aside for the specific purpose of paying for emergencies helps you avoid taking on new debt—and the stress of interest payments that comes with it—or borrowing from savings such as retirement. And once you’ve met your emergency savings goal, you can invest that money elsewhere knowing that you can most likely manage any unexpected expense that comes your way.
1 “Survey: Fewer than 4 in 10 Americans could pay a surprise $1,000 bill from savings,” Bankrate, LLC, 1/11/21. 2 “5 Types of Financial Emergencies,” Academy Bank, N.A., 8/24/21. 3 In July 2020, John Hancock commissioned our seventh annual financial stress survey with the respected research firm Greenwald & Associates. An online survey of 589 workers was conducted between 7/28/20 and 8/14/20 to learn more about individual stress levels, their causes and effects, and strategies for relief. John Hancock and Greenwald & Associates are not affiliated, and neither is responsible for the liabilities of the other. 4 “Personal Finance: How much should you set side in emergency savings?”, The Spokesman-Review, 8/15/21.
John Hancock is not affiliated with Dave Ramsey, and neither are responsible for the liabilities of the other.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
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