If you've decided that 2026 is the year you'll start building a financial cushion but are unsure how much to aim for, know that financial experts advise saving for three to six months' worth of living expenses, says CNBC. You can also make this goal more achievable by saving for essential expenses instead of current lifestyle costs.
With a financial cushion, you can feel more at ease knowing you have a net if an emergency happens and a sudden, unforeseen expense occurs. It can help minimize stress and reduce your likelihood of having to rely on high-cost debt.
What Is the Meaning of a Financial Cushion?
A financial cushion is cash that you reserve and that is readily available in a separate savings account or checking account. It acts as a buffer or safety net for managing financial risks, such as unexpected expenses outside of your everyday spending.
What Is Another Name for a Financial Cushion?
Many people also refer to a financial cushion as a "cash cushion" or an "emergency fund." Although used interchangeably (as they both offer a financial cushion for unexpected expenses), the former typically refers to a smaller amount.
What Is a Cash Cushion?
As an article published by NBC Boston explains, a cash cushion can help cover everyday surprises and is usually around $100 to $200. You keep this in your checking account at all times, untouched.
You can use your cash cushion as financial security for:
- Overdraft fees
- Timing problems with recurring payments
- Unexpected charges
Following this expert financial advice can give you more financial peace of mind, given that the above charges, while small, can add up quickly.
According to the Consumer Financial Protection Bureau (CFPB), overdraft fees can cost up to $30 per overdraft. Financial institutions could charge this multiple times in one day. They may even charge other fees if you don't pay these shortfalls within a few days.
What Is an Emergency Fund?
An emergency fund is a dedicated savings account that should hold at least three to six months' worth of your living expenses.
By recognizing the importance of emergency fund savings, you can motivate yourself to start setting aside money to cover bigger unexpected expenses, such as:
- Home repairs
- Car repairs
- Medical bills
- Temporary loss of income
How Much Financial Cushion Do You Need?
Ideally, you should aim for the highest amount you could set aside. Instead of only putting away $100 as your cash cushion, for instance, go for $200 if it's financially feasible. Likewise, your emergency fund goal should be to save up enough to cover six months' worth of living costs.
However, you can always start small and continue aiming for bigger goals.
Suppose three months' worth of living expenses is a bit too high for you at the moment. In this case, reconsider what your "living costs" are, focusing only on the essentials (e.g., food at home, utility bills, transportation, and mortgage or rent).
If you remove the non-essentials from your list (e.g., restaurant meals and entertainment), you'll find that the amount you save can be significantly more. By following this building savings strategy, setting aside three, even six months' worth of essential expenses, will be easier to achieve and manage.
Then, once you've saved up enough to cover six months of essential expenses, you can continue making "contributions" to your emergency fund so that it can cover some of your wants (e.g., dining out or going to the movies occasionally).
How Do You Build a Financial Cushion?
The first step to building a financial cushion is to understand your budget, which includes your income and expenses.
When you know how much your expenses are, you'll have a more accurate figure of how much to set aside in your emergency fund. Budgeting also lets you determine if your income matches your expenses, or if you need to cut down on non-essentials so you have enough left-overs to put into your savings accounts.
If you're only starting, consider reviewing the things you don't need to "survive." Too many restaurant meals, subscriptions (e.g., cable TV plus streaming), and shopping expeditions can chip away at your budget quickly, leaving you less room to save.
You can also explore other sources of income and get more opportunities to save. Freelancing side gigs you can do during your days off are a perfect example.
Life insurance is another. Today's policies should be more than just safety nets; they should offer benefits that deliver real value, as pointed out by EverlyLife.com. Fortunately, the best ones do, allowing you to build cash value, which you can then use to supplement your income.
Frequently Asked Questions
Is There a Specific Bank Account for Emergency Funds?
There's no single specific type of bank account exclusively for emergency funds. Still, there are several places where you can keep yours and enjoy more benefits than if you just put it in a traditional savings account.
One is a high-yield savings account (HYSA). As the term suggests, it pays a higher annual percentage yield (APY) than a standard savings account (e.g., 4% vs. 1.5%).
A money market account is another. It usually has an APY higher than a typical savings account, although it's not as widely available as HYSAs.
Should You Build a Financial Cushion First Before Paying Down Debt?
You should do both.
You need to pay your debt down; otherwise, you'd rack up more in interest fees and late charges. Whenever possible, avoid paying just the minimum amount due, as the remaining balance will only keep incurring fees the longer it remains unpaid.
At the same time, you should set aside as much as you can every month toward your financial cushion (both your cash cushion and emergency fund). Doing so can help you avoid taking on new credit when emergency expenses arise.
Start Building Your Financial Cushion Today
Building a financial cushion can help strengthen your finances and give you peace of mind, knowing you have a "safety net" to fall back on if an emergency occurs. It can help you avoid taking on more debt than necessary while also letting you grow your money, which is why you should start saving up as early as today.
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