The Importance of Emergency Funds and Safety Nets

Establishing a solid emergency fund is a fundamental aspect of financial planning. It serves as a safety net, providing financial security through difficult and unexpected times, like when you lose your job, have a medical emergency, or a major expense pops up unexpectedly (like home repairs). Without this safety net, you could end up collecting high-interest debt or depleting your savings account to cover your expenses.

You can keep your emergency fund in a variety of different accounts, but it’s best to keep it relatively liquid so you can access it at any time without losing some of it to fees.

Here's why everyone needs to build an emergency fund that remains separate from their savings account.

1. Protection against lost income

There are a variety of ways in which you might lose some or all of your income unexpectedly, leading to financial instability and difficulty meeting daily expenses. An emergency fund provides a buffer for you to maintain your standard of living while you look for new sources of income.

For example, if you get injured at work, but your workers’ compensation claim gets denied, having an emergency fund can carry you financially while you hire a lawyer to get your claim sorted out. If you have to fight for workers comp benefits, you won’t see the money immediately, and your household bills can pile up quickly. You’ll need to rely on your emergency fund.

Financial experts say it’s best to save between three and six months’ worth of living expenses to prepare for the unexpected. It can take time to find a new source of income, and being prepared will help you avoid going into debt or having your bills go to collections.

2. You’ll have the freedom to move

If you want to move to a new area, especially if it’s out of state, you’ll need to secure a job before you leave. However, that’s not always possible. Sometimes it’s necessary to take a leap of faith and move before you have it all sorted out.

Having an emergency fund will provide you with the financial resources needed until you find a replacement for your income. It can cover your essential expenses, like rent or your mortgage, utilities, and groceries. For some people, moving simply wouldn’t be possible if they didn’t have an emergency fund.

3. You won’t collect high-interest debt

Without a source of emergency funds, you may not have a choice but to start living on credit and payday loans. Payday loans are the worst form of debt because the interest is so high it’s hard to escape, but credit card debt can be equally destructive. Having a financial safety net will help you pay all of your bills on time, avoid high interest charges, and avoid getting trapped in the cycle of borrowing money.

4. You’ll have peace of mind

Money can be a stressful topic to deal with, especially when you’re facing unexpected expenses and you don’t have the funds to cover it all. According to data sourced by Fidelity, 35% of Americans wouldn’t be able to cover an unexpected $400 expense. This makes establishing a safety net crucial.

Nothing can create stress like being unable to pay your bills. By building up an emergency fund, you’ll have a sense of security and the ability to make financial decisions more confidently.

Tips for building your emergency fund

Establishing an emergency fund isn’t hard – it just takes a little effort and commitment.

1. Make regular contributions

Your emergency fund will only grow if you feed it on a regular basis. Commit to tucking away a certain amount, whether it’s based on each paycheck or by the month.

2. Cut your expenses

The more money you can save, the bigger your emergency fund will become. Cut unnecessary expenses so you can throw more money into your emergency fund each month.

3. Deposit extra cash whenever possible

In addition to making your regular contributions, start depositing extra money into your emergency fund when you have money to spare. For example, if you get a cash bonus at work, or you get change back from the store, put it into your emergency fund. No amount is too small because it all adds up over time.

4. Replenish what you use

There will be times when you’ll need to use the funds in your account, so make it a priority to put back what you withdraw from your emergency fund.

Build your financial safety net

Be proactive about your financial health. Create an emergency fund to protect yourself from financial shocks that would otherwise create debt or cause long-term financial harm.