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Why You Should Focus on Building an Emergency Savings Fund

Personal Finance
Parents like this dad may need to set aside more emergency savings to help protect their family.

If there's one thing you can expect in life, it's the unexpected. Whether it's a blown transmission in your car or the sudden loss of your job, sometimes it's hard to know when a major financial challenge is around the corner.

That's why having a solid emergency savings fund could be helpful to your long-term financial health.

By having money set aside for those setbacks, you may be able to avoid taking on extra debt. Here's what to know about emergency savings, as well as guidance around estimating how much you may need.

What's an Emergency Savings Fund?

An emergency fund is money set aside for unexpected financial challenges, such as a job loss or a sudden expense. Unlike a "rainy day" fund that covers lesser costs, an emergency fund is designed to protect you even in the face of a significant financial hurdle.

You might want to consider putting your money in a bank or credit union account that you can tap whenever you need it. While these accounts may not enjoy the same potential for growth as stocks or even bonds, you'll know that your principal is likely safe at your time of need. And with a federally insured bank account, up to $250,000 is protected in the account in the unlikely event that your banking institution faces financial trouble.

While certificates of deposit are typically protected by the Federal Deposit Insurance Corporation (FDIC) — or in the case of credit unions, by the National Credit Union Association (NCUA) — many have early withdrawal fees that make them ill-suited for an emergency fund. Those looking for a comparable rate of interest might want to consider online, or "high-yield," savings accounts that may provide slightly higher payouts than traditional banking products. Many are federally insured, and while some have limits on withdrawals you can take, you can generally withdraw money at any time after establishing the account.

While you may have money invested in a retirement plan, you may want to keep a separate, easily accessible account just for emergencies. Money pulled from a retirement plan typically can take weeks to access and could result in potential early withdrawal penalties or possible tax liabilities. Plus, there's a chance you may have to withdraw money when the market is at a low ebb, a scenario no individual wants to experience.

How Much Do You Need?

To prepare yourself for a sudden loss of income or a large bill, it's generally a good idea to have enough money set aside that can cover at least three to six months' worth of expenses. Unfortunately, many Americans are well shy of that goal. A Federal Reserve survey from 2020 found that, if faced with an unforeseen $400 expense, only 64% of adults could pay it off with cash, savings, or a credit card paid off at the next statement.

While rules of thumb can be helpful in determining the size of your emergency fund, your savings goal should ideally be based on your individual circumstances. For example, adults who have no dependents — and have family members that can provide support during challenging times — might be in good shape with a fund that can handle three months of outlays. On the other end of the spectrum, individuals with unstable income and parents with young children might want enough saved for six months or more to enjoy an adequate safety net.

Estimating Your Expenses

Identifying a target savings amount generally requires having a strong grasp of how much you spend in a typical month. If you pay all your bills from a single checking account, it might be easy enough to glean from pouring over your recent bank statements.

For those with a more complicated financial picture, figuring out what you live on could take a bit more work. In a worst-case scenario, there might be certain expenses you could forego, like gym memberships. But you may want to account for everything that's not discretionary, which is probably a longer list than you imagine.

Your list of monthly non-discretionary costs might include:

  • Mortgage or rent payments
  • Grocery bills
  • Utility bills
  • Health insurance premiums
  • Life insurance premiums
  • Credit card payments
  • Car loans and other debt
  • Child care costs

Our Emergency Fund Calculator can help you tally your individual monthly expenses. And based on your target savings amount, it will tell you how much you may want to consider setting aside as either a lump sum or as monthly installments to meet this important goal. If you think you could benefit by speaking with an experienced financial professional, don't hesitate to reach out for individualized guidance.

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Information provided is general and educational in nature, and all products or services discussed may not be provided by Western & Southern Financial Group or its member companies (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.