Building an emergency fund is one of the most evergreen recommendations we give to people. Having some money saved up does wonders when you face a financial setback like car repairs or a broken dishwasher.
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Recently, we learned that our friends at the investing platform Lightyear have the perfect product for holding your emergency fund: Lightyear Savings Vault. It offers 3.61% APY interest on savings without having to lock your money.
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So, we joined forces with Lightyear to write the ultimate guide on the emergency fund: why you need it, how to earn interest with it, and even how it fits into your investment strategy.
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Above all, we kept it super practical, giving you actionable steps to follow.

Table of Contents:

An emergency fund is a savings account set aside to cover unexpected expenses, such as replacing home appliances, car repairs, or job loss. It serves as your financial safety net, providing funds to manage emergencies without relying on credit cards or loans.

Typically, an emergency fund should cover three to six months' worth of living expenses and be kept in an easily accessible savings account.

As the name suggests, an emergency fund helps you cover significant unexpected expenses. Having such money set aside offers many benefits to your mental and financial well-being. A sufficient emergency fund reduces financial stress, providing you with confidence in handling life's uncertainties.

Financially, it helps you avoid using high-interest debt, such as credit cards or loans. If you are investing, it also ensures that you don’t have to exit investments at a disadvantageous time.

The general advice is that your emergency fund should cover three to six months' worth of living expenses. This ensures you have enough money to handle most unexpected situations, including job loss, without falling into debt.

The size of your emergency fund also depends on personal factors. Consider a larger emergency fund (six months or more) if you value stability, have children or dependents, have irregular income, or are engaged in riskier financial activities such as starting a business.

Whereas, a smaller emergency fund (closer to three months) might be suitable if you have a higher tolerance for financial risk, have a stable job and your monthly expenses are low.

When determining the optimal size of your emergency fund, start from calculating your minimum monthly expenses.

First, list all essential costs, such as housing, utilities, groceries, transportation, and other necessary bills. Then, track the current monthly expenses for optional spending like dining out, entertainment, travel and shopping. Estimate how much you could cut those items in the case of losing a job. Chances are that you could reduce your monthly expenses significantly if you really need to. Finally, settle on a realistic number for monthly expenses that also includes these lifestyle cuts.

If you are already using the Bilance app, the process should be fairly simple. Your expenses are already categorized, and you can see your average spending over multiple months, giving you a more accurate picture.

The ideal place for the emergency fund should meet three criteria: 1) easily accessible, 2) safe, and 3) earning interest. Specifically, the best option is a high-yield account.

Your entire emergency fund should be accessible under 24 hours, without any fees or restrictions. Avoid investing your emergency fund in stocks, as they may fluctuate significantly. Additionally, your emergency fund should earn you some interest while you don’t need to tap into it.

In the Baltics, Lightyear Savings Vault* is a compelling option for storing your emergency fund:

Use code BILANCE24 when signing up to Lightyear to get 10 free trades and let them know we sent you.

The benefits of Lightyear Savings Vault are best explained by comparing it to alternatives: holding cash in a bank account and fixed-term deposits. The most important factors to consider are ease of accessibility and interest rate.

Cash in a bank account excels in accessibility, as it’s always immediately available. However, a bank account usually earns low or no interest.

Fixed-term deposits do earn interest. The downside is that they are either not accessible during the lock-in period or accessing them prematurely voids the earned interest. This is not ideal for an emergency fund, as you usually can’t predict when you might need the money.

Lightyear Savings Vault combines the benefits of both. Money stored in Savings Vault is quickly accessible. Additionally, the interest on your savings is calculated daily and paid monthly. This means you can move your money in and out while continuing to earn interest.

Use code BILANCE24 when signing up to Lightyear to get 10 free trades and let them know we sent you.

Not really. We recommend keeping the emergency fund in a dedicated account without a debit card. The emergency fund should only be used in case of an emergency. Keeping the money in a separate account helps avoid accidentally tapping into it.

Additionally, a regular bank account often earns no or low interest, while keeping the money separately on a high-yield account helps you earn more interest.

The most important thing is to start. If you currently have no savings, the first few hundred euros saved will have the largest impact. This initial amount will already shield you from many financial hardships and provide a boost to your financial security.

One of the most effective tactics is to automate transfers to a high-yield account. Setting up a recurring transfer immediately after receiving your salary ensures consistent contributions.

Begin with small, manageable amounts and gradually increase them as you can. Your initial goal can be much lower than 3-6 months of living expenses. Even setting aside the first 500€ will help you a lot in the case of an emergency.

If you encounter a genuine financial emergency, don't hesitate to use your savings! Such emergencies are typically large, unexpected, and unavoidable expenses like car repairs or sudden job loss.

For costs that are unexpected but manageable within your regular monthly budget, consider adjusting your spending for a while instead of dipping into your savings.

If you anticipate a large upcoming expense, start saving for it ahead of time to avoid tapping into your emergency fund.

Finally, resist the temptation to use your emergency fund for entertainment purposes like traveling. As the name suggests, you never know when you might actually need the money.

In any case, make it a priority to restore your emergency fund after using it to maintain your financial security.

We recommend building your emergency fund before focusing on other investments.

While your emergency fund won’t have the highest returns, it’s a critical foundation for your wealth. An emergency fund helps you avoid costly scenarios, such as being forced to exit investments due to urgent need of money or using high-interest credit for big purchases. Additionally, it provides you greater confidence and financial stability, allowing you to take on more investment risk later.

The emergency fund can still provide you with some return when using a high-yield savings account.

Yes, it can. The emergency fund has an optimal size and can be both too small and too large, especially if you’re building an investment portfolio. See previous answers to find the optimal amount for you.

An overly large emergency fund can hurt the returns of your overall investment portfolio. While your emergency fund is ideally earning interest, the returns on cash and its equivalents are typically lower than returns on other financial assets like stocks, bonds and ETFs.

To maximize returns, reconsider the size of your emergency fund periodically and adjust as needed.

The primary value of an emergency fund is reducing financial stress and protecting you from setbacks, rather than earning a high return.

Credit cards typically carry annual interest rates starting at 16% and payment plans for electronic devices can exceed 25% APR (Annual Percentage Rate, meaning the actual yearly cost of a loan, including interest and fees). Payday loans can even cost upwards of 50% APR. Not having to use those costly solutions is your return on the emergency fund.

Additionally, the emergency fund can still provide you with some return when using a high-yield account.

Use code BILANCE24 when signing up to Lightyear to get 10 free trades and let them know we sent you.

* Disclaimer: Provider of investment services is Lightyear Europe AS. Lightyear Savings Vault allows you to invest into money market funds, where the value of investment can go up or down. Yield (APY) shown is net, variable and correct as of 15.07.2024. Terms apply, seek guidance if needed.

Lightyear Savings Vault is available in Austria, Estonia, Finland, France, Germany, Hungary, Italy, Lithuania, Luxembourg, Netherlands, Spain and the UK.