Mindful money
Aug 27, 20215 min read

Creating an emergency fund: How to set it up and why you should.

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by Klarna

By their very definition emergencies are unplanned. But when an unexpected situation arises, being financially prepared can alleviate a bit of the stress that often accompanies a crisis. 

Whether you’ve experienced sudden job loss, face mounting medical bills or have encountered another significant event that impacts your financial situation, having an emergency fund can provide peace of mind at an unsettling time.

While this monetary safety net is an important component in a well-rounded personal finance plan, few make it a priority. In fact, according to a recent Klarna survey of Millennial and Gen Z consumers, only 5% of Millennials and 4% of Gen Z are saving for an emergency fund. Yet, during the pandemic, Millennials, who carry an average student loan balance of $38,877 per borrower, were hit the hardest by job cuts, forcing many to take on additional credit card debt.

Having a savings account earmarked for emergencies can help avoid falling into a debt trap. But even those who are ready to establish a separate fund may have questions such as: how do you get started, how much should you save, and where should you keep this spare cash? 

The following suggestions, offered by the Consumer Finance Protection Bureau, can help get the ball rolling.

Determine your monthly expenses.

Before you can figure out how much you should sock away in an emergency fund, you need to create a budget. This will help you evaluate your income and expenses, which in turn allows you to determine how much you can afford to save—and how much you need to stay afloat should something dire occur that derails your income or demands a large outlay of capital.

Look at your fixed expenses (items like your mortgage and auto loans) and your variables (entertainment, travel) and see where you can cut corners if you don’t have much left over to put toward an emergency fund.

How much should you save?

The amount of money you’ll actually need in a crisis varies based on the nature of the emergency. An auto repair may set you back a few hundred dollars while the loss of a job could require that you have thousands available to cover your costs while you search for a new position.  

As a general rule, experts recommend saving enough money to cover between three and six months’ worth of living expenses. Take a look at your budget to determine that amount.

How long will it take to reach your goal?

Once you’ve established how much you need to save, you have a goal. But hitting that target may seem like a challenge. The CFPB recommends using a savings planning tool to help figure out how long it’ll take to put away the amount you need. Putting money away in manageable increments makes saving seem a bit less daunting.

Find a way to make ongoing contributions.

It’s hard to miss money that’s never made its way into your wallet. Making direct deposits from your paycheck into an account earmarked for emergencies allows you to save consistently and eliminates the temptation to spend more than you should. If you find yourself with extra cash, you can always add to your emergency fund and reach your goal faster. 

Where should you save?

When an emergency hits, worrying about how you’ll access cash is the last thing you need. With that in mind, set up an interest-bearing savings or checking account that comes with an ATM/debit card. While it might be tempting to invest in stocks, bonds, or mutual funds, you don’t want your money fluctuating with the markets or tied up in long-term instruments that you may not be able to sell profitably should the need arise.  

Don’t be afraid to adjust your goal.

Should your situation change, don’t be afraid to make adjustments. For example, if you move and your mortgage payment increases, you’ll want to boost the amount of your emergency fund to cover that higher cost. Conversely, if you pay off student loans and that expense rolls off your balance sheet, you can consider decreasing the amount you contribute toward your emergency fund.

 

While an emergency fund is something you hope you don’t need, if an unfortunate and expensive crisis arises, having cash available to see you through is one less stressor. It can also help you avoid relying on credit, which could drastically worsen your financial situation over time due to interest and fees.