A savings account and an emergency fund may seem similar at first glance, but there are important differences between the two. In a nutshell, an emergency fund has money set aside for unexpected expenses, while a savings account is used to keep money to pay for specific goals, whether they be long or short-term. Let’s take a closer look at their differences and learn how to get the most out of them.
What is an Emergency Fund?
An emergency fund is a savings account that’s specifically designated for unexpected expenses. It should provide you with a financial safety net so you can cover things like medical bills, car repairs, urgent travel expenses, or job loss without going into debt or having to dip into your regular savings.
Most financial experts recommend having at least three to six months’ worth of living expenses saved in your emergency fund. This means that if you spend $3,000 per month on living expenses, aim to have between $9,000 and $18,000 saved in your emergency account.
It’s important to keep your emergency fund in a liquid account, such as a savings account or money market fund, so that you can access the money quickly if you need it. Having a debit card or online access to the account can come in handy for those situations.
What is a Savings Fund?
A savings fund is a more general savings account that can be used for a variety of purposes. This can include things like saving for a down payment on a house, a car, a college education, or retirement.
Savings funds can be held in a variety of accounts, including savings accounts, money market funds, or certificates of deposit (CDs). Unlike emergency funds, there’s no set amount of money you need to have saved in your savings fund. Instead, aim to save as much as possible based on your financial goals. This is why savings accounts are typically intended for long-term goals like buying your dream home, going on a sabbatical, or building wealth.
What Are the Key Differences Between Emergency and Savings Funds?
An emergency fund serves as your first line of defense when faced with unexpected expenses. It actually acts as a buffer for your savings fund, which can be your last resort in case your emergency fund is not enough to cover the expense at hand.
Amount of Money To Be Maintained
Another key difference is the amount of money you need to maintain in each type of fund. An emergency fund should be enough to cover at least three to six months’ worth of living expenses. In case a portion or all of it gets used, it should be your priority to replenish it first over your other funds.
The amount of money you need to maintain in your savings fund depends on its purpose. It could be less or more than the ideal amount of your emergency fund.
Your emergency fund needs to be easily accessible so you can withdraw the money right away when you need it. You don’t want to put them in a non-liquid account as you cannot withdraw money immediately with this type of account, which defeats this fund’s purpose.
As for your savings, you need it to grow as much as it can. That is why you need to keep it where the opportunities for withdrawing money are limited or restricted.
Emergency funds should be kept in low-risk accounts to ensure that the money is there when you need it. Meanwhile, savings funds can be invested in high-risk accounts like stocks or mutual funds, as long as you’re comfortable with the level of risk. Investments with high returns help grow your savings faster.
Finally, emergency funds should be given top priority with saving. If you still have debts to pay, financial experts recommend paying them off first while making small contributions to your emergency fund. This means you should focus on building up your emergency fund before you save for other goals like going on vacations or renovating your house.
Having money set aside for emergencies and specific goals helps you stay out of debt. Saving as much money as you can will let you enjoy greater financial security in life.