Goldman Sachs – What Is an Emergency Fund and How To Get Started
Editor’s Note: APYs listed in this article are up-to-date as of the time of publication. They may fluctuate (up or down) as the Fed rate changes. CNBC will update as changes are made public.
Life is unpredictable, and unforeseen expenses can pop up at any time — whether that’s medical bills, your car breaking down or an appliance that stops working. And if you’re struggling with unemployment, underemployment or overwhelmed with a slew of conflicting financial priorities, it’s easy to slip into debt in order to pay for everyday life, not to mention the bills you’re not expecting.
Building an emergency fund can give you the peace of mind that you’ll be able to manage when an unexpected cost pops up. It’s not always easy to save up a significant sum when you’ve got bills to pay, but even a few hundred dollars can help. And once you start saving, you might find it easier to build momentum and grow this account.
Ahead, CNBC Select put together a step-by-step guide on how to create an emergency fund so you can have money to access during worst-case scenarios.
What is an emergency fund?
Like the name suggests, an emergency fund is a lump sum of cash that you can access in the event of an emergency. There are no strict rules on what counts an emergency, but as a general rule of thumb it should only be used for essential expenses.
For example, you can use money stashed in an emergency fund to replace a broken fridge, but you shouldn’t tap into this account to buy a fancy coffeemaker. The key to a successful emergency fund is to only use it when you are in dire need.
While an emergency fund can help with unexpected bills, it can also help you make ends meet if you’re laid off. Unemployment benefits will help you afford some of your daily expenses, but generally it’s not enough to cover your entire cost of living. If you have an emergency fund, you can tap into it to cover the cost of everyday expenses, like utility bills, groceries and insurance payments, while you’re unemployed.
You should keep your emergency fund in a relatively accessible account, such as a high-yield savings account, that allows you to access money within a few days. Accounts like Marcus by Goldman Sachs High Yield Online Savings and Ally Online Savings Account both currently offer a 0.50% APY, which is 10 times the national average of 0.05%, according to the Fed. These accounts allow your emergency savings to earn an above-average APY, so you’ll have the added benefit of earning some interest on your savings.
How to create an emergency fund
1. Set a savings goal
The first step to building an emergency fund is to calculate how much money you can reasonably afford to save every month. To make the process easier, review your existing budget or create a budget. This helps you understand how much money you have leftover to save, after deducting fixed expenses like food, insurance and electric bills.
While experts typically recommend you have an emergency fund with about three to six months worth of your living expenses, the amount you should save is dependent on your situation. In times of financial hardship, like the coronavirus pandemic, you may not be able to save that much money, and even a few hundred dollars is a start.
The key is to save the maximum amount you can, without going overboard making big cuts to your budget. It’s okay to cut back on streaming subscriptions and takeout orders so you can save more, but make sure you don’t lose momentum because you’ve sacrificed too many perks.
2. Automate savings
Once you figure out how much money you want to have in an emergency fund, the next step is to start saving. The simplest way to save money is to automate it. Set up automatic, recurring transfers from your paycheck that go directly into your emergency fund.
This is a great way to remove the temptation of spending the money before you get a chance to save it. Whereas if you had your entire paycheck deposited into a checking account, you’d have to transfer it to your emergency fund on a regular basis. This delays the time it takes you to save and may cause you to spend the money or forget to transfer it.
While your savings should be automatic, you can also transfer additional money any time that you have money leftover after your other expenses are covered.
3. Monitor your progress
Automating your savings is a great way to passively add money to your emergency fund, but you shouldn’t set it and forget it. It’s important to monitor your progress and make sure you’re on track to meet your savings goal.
It’s also a good idea to make adjustments to your savings if your financial situation changes. For instance, if you get a raise or new job with a higher salary, consider increasing your contributions. Whereas if you’re laid off, you may need to temporarily pause or decrease the amount you save.
As with many things in life, saving for an emergency fund is ever-changing and you should check in regularly to reassess the situation and make adjustments as necessary.
When you’re facing unexpected bills, it’s great to have an emergency fund to tap that can cover some or all of the costs. You can easily create an emergency fund and get started through the three steps we mentioned above. Then you’ll have a safety net if unexpected expenses pop up.
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the CNBC Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.