How to Start an Emergency Fund (and Why You Need One)

Image by Gino Crescoli from Pixabay

If you have a financial emergency — an unexpectedly high medical bill, a sudden move across the country, or a job loss — how will you pay for it? Most financial advisors recommend keeping a separate emergency fund that you wall off from your retirement and other lifecycle-related savings accounts. This will allow you to meet urgent funding needs without having to take money from your retirement or educational accounts, which can lead to penalties and tax bills.

It can be difficult to get started with an emergency fund, especially if you’re focused on specific savings goals like buying a house or paying tuition. The best way to make saving a habit is to use behavioral-finance techniques to your advantage. Open an online-savings account at a bank that pays high interest rates, and set up automatic monthly transfers from the main checking or brokerage account where your paycheck gets deposited. That way, you won’t have to think about making a manual deposit. It’s okay if you start with a small amount; the important thing is to be consistent.

While you’re setting up your emergency fund, make sure that you’re earning the highest interest rate possible. This will harness the power of compound interest, which means that the money in your account will earn interest as it sits there, and, if you don’t take it out, will accumulate as the interest goes back into the account to earn even more interest.

Why does this matter? Your emergency fund, by design, is money that you are going to keep on the sidelines and — hopefully — never have to use. Because you are not going to invest it in securities, which are risky, you want to make sure that you can earn as much as possible in interest on your cash in this account. Earning higher interest can help your emergency fund keep pace with inflation.

It’s also important that your emergency fund be kept in an account that’s fully liquid. If you have to access this money, you may need it immediately; you won’t have time to wait the three days that a money market fund will take to get the money back to you. An online savings account solves this problem. You can have the money wired back to your checking account same-day.

Are these accounts safe? Any bank account that is FDIC-insured is backed by the federal government up to $250,000 per depositor, per account type, per institution. If the bank goes under — unlikely, but still possible — the FDIC will return your money up to this limit.

One good way to make sure your emergency fund is FDIC-insured and kept in the highest-rate online-savings accounts possible is to use technology solutions, like MaxMyInterest, to manage it. Max isn’t a bank; it’s software that automatically allocates your funds among high-yielding accounts at online banks, to make sure your money always earns as much as it can safely. You can learn more at MaxMyInterest.com.