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Savings vs. Emergency Fund: What's the Difference?
“Emergency fund” is an informal term for a savings account that’s set up for a special purpose—covering unexpected expenses.
In general, savings accounts can be used to pursue a wide range of financial goals, from paying for vacations and major purchases to addressing long-term needs. Some people can manage their finances just fine with one savings account, recognizing that they need it to be large enough to cover different things. For others, it helps to set up different savings accounts for specific categories. This makes it easier to gauge whether they are saving enough month to month.
Opening savings accounts for different reasons, including for emergencies, might help you with budgeting, money management, and gaining a sense of financial security.
What is a savings account?
A savings account is a secure place to store money you don’t need for daily spending but want to have easy access to when necessary. Account holders can deposit money occasionally or regularly through direct deposits. The money might earn interest, and possibly compound interest. Banks might charge a monthly maintenance fee, but they often give account holders ways to avoid the fees, such as keeping a minimum balance or linking to a checking account.
People use savings accounts to set aside money for planned expenses like vacations, holiday shopping, and home upgrades. These accounts also can be used simply as a safe place to keep money until it is needed. Account holders can withdraw money at their banks or at ATMs.
The FDIC insures most banks and covers up to $250,000 per depositor, per account category. Savings accounts are a low-risk way to earn interest without risking your principal.
What is an emergency fund?
"Emergency fund” is a casual term for money set aside specifically for life’s surprises. The purpose of building an emergency fund is to prepare for urgent situations like car repairs, home repairs, or medical bills. It also could provide a buffer in the event of job loss or other sudden changes in income.
“Rainy day fund” is a similar term used for savings that are reserved for unidentified expenses. Some think of it this way: A rainy day fund is for expenses that are not part of your monthly budget but aren't entirely unexpected, either. For example, it might be used to buy new tires for your car or new brake linings, so the car passes its annual inspection. An emergency fund would be used to make repairs after a tree branch crashed through your roof.
Whatever you call it, the point is to have money set aside so you can avoid taking on debt or eroding retirement savings to manage a difficult situation.
When to use your savings vs. emergency fund
The key difference between a general savings account and an emergency fund savings account lies in how and when the money is used. When you assign specific roles to each account, you can get a clearer picture of each one and whether you have enough to cover essential needs.
When to use your savings account
A savings account is ideal for short-term and planned goals. Consider dipping into your savings account to cover expenses like:
- Vacations or holiday trips
- Home upgrades like new appliances or furniture
- Technology upgrades (new phone, laptop, or TV)
- Down payments on home purchases or vehicles
By setting financial goals and budgeting, you can earn interest on your money until it's time to make a big purchase. This can be more cost-effective than making a large purchase on credit and then paying interest for months or years.
When to use your emergency fund
Your emergency fund is reserved for true emergencies—unexpected events that require immediate attention and funds. This could include:
- Car repairs resulting from an accident
- Sudden home repairs (like a burst pipe or damaged roof)
- Medical expenses not covered by insurance
- Expenses due to job loss or income reduction
An emergency fund could help you maintain financial security and avoid taking on high-interest debt. When life throws unexpected costs your way, you’ll have a solid base for dealing with it.
How much do I put in my savings account?
One practical way to manage your finances is by using the 50/30/20 rule, a popular budgeting strategy. This method divides your income into three categories:
- 50% for essentials. Rent or mortgage, groceries, transportation, and utilities
- 30% for wants. Dining out, travel, hobbies, and entertainment
- 20% for savings. This portion can be allocated toward general savings, building an emergency fund, retirement savings, and other financial goals
Having a clear money management strategy, whether it’s the 50/30/20 rule or another guideline, can help you to save regularly while covering your other costs. Many people set up automatic transfers into their savings account to build up funds steadily.
How much do I need to save for an emergency?
Many experts, including Fidelity† Investments and finance guru Dave Ramsey †, recommend† having three to six months' worth of essential expenses saved in your emergency fund. These essential expenses include:
- Mortgage or rent payments
- Utilities and groceries
- Insurance premiums
- Transportation costs
If three months seems overwhelming when you start building an emergency fund, aim for just one month. When you achieve that, review your budget to see how you can start saving more each month.
The point of having three to six months' worth of expenses covered is to cushion the blow of an unexpected job loss or another situation that impacts your ability to earn an income. Having a few months' worth of savings could give you time to find a new job or get back on your feet without resorting to credit cards and other loans.
Accessibility is key for an emergency fund. A savings account, and some types of high-yield savings accounts, offer quick access to the money without penalties.
Savings accounts offered at TD Bank
By distinguishing between a savings account and an emergency fund, you can develop better savings strategies to prepare for life’s planned adventures and unwelcome surprises.
At TD Bank, you’ll find a variety of savings accounts designed to meet your individual needs, whether you’re focused on short-term goals or building an emergency fund.