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Actions Avoid These 5 Emergency Fund Mistakes
Key Takeaways
- Properly fund it — save enough for three to six months of expenses.
- Leave it alone — it's not meant for discretionary spending.
- Be a good borrower — pay yourself back after drawing down the balance.
Congratulations on making the commitment to create an emergency savings account for your family. You'll be ahead of most Americans —about 60% can't afford a $1,000 emergency Opens in new window — and having money set aside for the unexpected is a huge step toward financial security. But you'll want to be smart about your emergency fund. Watch out for these common mistakes, which could leave you less prepared than you think.
Mistake #1: You haven't saved enough
Having three to six months' worth of nondiscretionary expenses saved in an emergency account is a good rule of thumb. However, the right amount is different for everyone depending on their financial circumstances. If you are secure in your job and don't have dependents, you likely need less emergency savings than if you have children or an unpredictable income.
Remember, you don't need three to six months of all your expenses, just “must-haves” such as your mortgage or rent, utilities, taxes and insurance bills. Whatever you're spending now on discretionary items like dinners out, vacations and shopping, you could eliminate in a real emergency. Once you've set aside enough cash, redirect your savings to longer-term goals such as retirement or a home down payment.
Mistake #2: Your money is in risky investments
The stock market is not the place for your emergency money. Instead, keep it in a liquid, easily accessible place such as a savings or money market account, or invest in a conservative investment such as a stable value fund. Sure, you won't earn much of a return on your money, but you can easily tap into it when needed, and there's little risk that the account will lose value. Remember, this fund is designed to support you in a worst-case scenario, not to save for the long term.
Mistake #3: You make withdrawals for non-emergencies
Tempting as it may be to tap into your emergency fund when discretionary expenses push you over your monthly budget, avoid this impulse. Summer vacations and holiday shopping aren't real emergencies. If you draw down your emergency fund for discretionary spending, you may find yourself in financial trouble when a true emergency arises.
Mistake #4: You don't adjust your savings target as needed
If your family grows, or you move to a more expensive home, you may need to increase the amount you set aside for an emergency. It may also be a good idea to build up your emergency fund if you believe that your job is in jeopardy. Similarly, if you downsize, or your kids finally move out of your home, you may be able to reduce the amount of money in your emergency account. If you're meeting all your other financial goals, consider redirecting extra cash to an investment account where you can accept some risk to the principle for potentially better returns.
Mistake #5: You forget to replenish after an emergency
If you do tap into your fund after an actual emergency like unexpected medical bills or car repairs, it's important to build it back up again. Once you're back on your feet, prioritize monthly contributions to your emergency fund to make sure that it's there the next time you need it. Rebuilding your savings may be easier the second time around, especially after you experience the relief of having a financial safety net.
What you can do next
If you don't have the cash to set aside a full three to six months' worth of expenses right now, grow it over time by making regular contributions through automatic deposits. See whether your employer offers any programs aimed at helping workers establish an emergency fund.
Footnotes
Beth Braverman is a freelance writer covering personal finance, parenting, and careers. Her work has appeared in dozens of publications, including Consumer Reports, CNBC.com, and CNNMoney.com. She lives with her family in Westchester County, N.Y.
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