An emergency fund is a critical part of any financial plan. Budgets and savings goals fall by the wayside if you don’t have money set aside for an unexpected expense, whether it’s a surprise car repair, a doctor’s bill or sudden unemployment.
According to a recent CNBC and SurveyMonkey Quarterly Money Survey, 63% of Americans say they are living paycheck to paycheck. Half of those surveyed said just a one-week delay in pay would cause a major financial hardship.
Creating a safety net can seem impossible when you’re barely able to cover your expenses, but that’s when you need one the most. The key to building an emergency fund when you’re living paycheck to paycheck is starting small.
What is an emergency fund?
An emergeny fund provides a cushion if you’re hit with a surprise expense or your usual source of income dries up. Only you can decide what an emergency is, but the account should be for essentials, not maintaining your normal lifestyle. Ask yourself if waiting would cause a practical problem (like not having transportation) or additional financial hardship (like high-interest credit card debt).
Good reasons to use your emergency fund:
- Rent/mortgage
- Utilities
- Groceries
- Insurance
- Transportation
- Minimum debt payments
- Medical or childcare costs
Usually not expenses for an emergency fund:
- Vacations
- Dining out or shopping
- A planned car purchase
- A down payment on a house
If you have sizeable expenses that are predictable but difficult to budget for, like vet visits or new tires, consider a separate sinking fund, rather than taking money out of your emergency fund.
Building your emergency fund, $1 at a time
Experts recommend saving three to six months of essential living expenses to cover housing, food and other essentials if you lose your job or face a major crisis. If your essential expenses are $4,000 per month, your emergency fund would be $12,000 to $24,000.
That can seem like an insurmountable amount. But your first goal is to make sure that one unexpected bill doesn’t trigger a debt spiral — even $25 per pay period is a start. Set a goal of $250, and then $500. From there, try to put away one month’s expenses.
- $10 per paycheck = about $260/year
- $25 per paycheck = about $650/year
- $50 per paycheck = about $1,300/year
If you deposit $25 per paycheck into a HYSA earning 4.00% APY, you’ll have about $663 saved after 12 months, assuming the rate stays constant.
Contributions: $25 × 26 biweekly paychecks = $650 Interest: about $13 Balance: about $663
If your budget is extremely tight, start with just $5. At this stage, the habit matters more than the dollar amount.
Make a budget, even if it’s not perfect
It can feel like money disappears as soon as it comes in, but making a monthly budget can help you see where it’s really going. A back-of-the-envelope approach is okay, but there are free budgeting apps that help you organize your finances and spot small changes you can make.
Rocket Money has a free version that tracks spending, subscriptions and bills across all your linked accounts. SoFi Relay can automatically organize transactions into 15 main categories and 100+ subcategories, while Goodbudget lets you create individual buckets, or savings goals, including for an emergency fund.
Open a high-yield savings account
It’s a smart idea to keep your emergency fund somewhere separate from your everyday checking account so it’s harder to dip into. Money in a high-yield savings account (HYSA) can earn a healthy return and still be accessible when the time comes. And setting up a regular automatic transfer lets you build your emergency fund without thinking about it.
Happen Bank’s LevelUp Savings has one of the most robust APYs on the market and is one of the few HYSAs to come with an ATM/debit card.
Don’t overlook one-time windfalls
Setting aside money from every check is a key part of building an emergency fund, but we all come into unexpected money from time to time:
- Work bonuses
- Overtime or additional shifts
- Tax refunds
- Cash gifts
- Selling items you don’t use anymore
Don’t view these one-time payments as “free money,” especially refunds. They can provide an unexpected opportunity to save. Even if you can only devote half of a windfall to your emergency fund, it can make a difference over time.
Keep your credit card in your wallet
If you can, cover surprise expenses with your emergency fund, not a credit card. An emergency fund is money you’ve already saved — a credit card is borrowed money. The interest on your card can eat up any earnings on your emergency fund.
If your emergency fund earns 4% APY, but your card charges even 10% APR (less than half the national average), you’re losing money by charging that expense and keeping the cash invested.
If your car needed a $1,500 repair:
- Paying with an emergency fund: You’d spend $1,500 and give up roughly $60 in interest you could have earned over a year at 4% APY.
- Paying with a credit card: If you’d charged $1,500 to a credit card with a 10% APR and carried the balance for a year, you’d pay roughly $150 in interest.
If you use savings, your future paychecks aren’t committed to paying off an old emergency.
That said, you don’t necessarily want to drain your emergency fund completely. If an expense is large enough that paying cash would leave you with no buffer, it may make sense to use a combination of savings and credit. But paying that card down aggressively is now your top priority.
