How to Stop Living Paycheck to Paycheck (5/5): Why You Need an Emergency Savings Fund and a High-Yield Savings Account
Welcome to part five of our series on how to stop living paycheck to paycheck. Today, we’re tackling two critical aspects of financial security: building an emergency savings fund and utilizing a high-yield savings account.
The Importance of an Emergency Savings Fund
Life is unpredictable. Whether it’s a car accident, a sudden medical emergency, or an unexpected job loss, financial setbacks are bound to happen. While we might not like to think about these scenarios, being financially prepared is essential. An emergency savings fund can help you weather these storms without resorting to debt.
How Much Should You Save? A good rule of thumb is to save 3 to 6 months' worth of expenses. This amount should cover your basic living costs, ensuring that you can maintain your lifestyle for several months even without an income. This cushion gives you time to get back on your feet without the added stress of financial instability.
How to Build Your Emergency Fund
There are two main approaches to building your emergency fund:
Steady Contribution: Set a fixed amount to contribute from each paycheck. For example, my husband and I decided to save $100 per week, and it took us a little under two years to save up three months' worth of expenses. This method allows you to build your fund at a comfortable pace.
Speed Run: If you need to build your fund quickly, set a minimum contribution amount and then add every extra dollar you can find. This might mean skipping your daily coffee or canceling a subscription service. The extra money you save from those sacrifices will add to that emergency fund. The more frugally you live during this period, the faster your emergency fund will grow. Once you reach your goal, you can resume your previous lifestyle—now with added financial security.
Using Your Emergency Fund
When an emergency does occur, don’t hesitate to use your fund—that’s what it’s there for. Afterward, make it a priority to rebuild the fund as soon as possible to prepare for the next potential emergency.
Why a High-Yield Savings Account?
While building your emergency fund, consider placing it in a high-yield savings account. These accounts offer a higher interest rate than standard savings accounts, allowing your money to grow even when you’re not actively contributing to it.
Example: I use E-Trade, which currently offers a 4.5% interest rate. Other good options include Ally Bank at 4.2% and SoFi at 4.6%. Last month, my emergency fund of $10,000 earned me $36 in interest just by sitting in the account. While high-yield savings accounts typically offer lower returns than investments, they are less risky and more accessible.
Accessibility and Risk
High-yield savings accounts are ideal for emergency funds because they are easily accessible, usually allowing transfers within 1 to 2 business days. In contrast, investments can take longer to sell and may result in a loss if you’re forced to sell at an inopportune time.
By keeping your emergency fund in a high-yield savings account, you ensure that your money is safe, accessible, and still working for you. Next time, we’ll dive into the world of investing, so stay tuned!
