- An emergency fund can help you weather financial crises and unexpected expenses
- Financial advisors recommend saving at least three months' worth of expenses
- Multiple savings vehicles can make sense for an emergency fund
Everyone faces unexpected expenses or financial emergencies at some point in their lifetime, from a medical event to a car repair to a sudden change in housing. The key to weathering these financial predicaments without taking on debt is an emergency fund.
An emergency fund, or contingency fund, is money set aside for unexpected financial emergencies or expenses. This cash reserve can help cover medical bills, home repairs, a loss in income or other urgent financial needs.
How much should you have in an emergency fund? At minimum, most financial advisors recommend saving at least three months' worth of living expenses. However, with 51% of Americans reporting that they have less than that in their savings, the most crucial step is simply to start an emergency fund — and then helping it grow.
Read on for more information about why an emergency fund is so important and how you can set one up.
The importance of an emergency fund
Think of your emergency fund as a financial safety net. Having money set aside in an emergency fund gives you access to a cash reserve when you need it most. That access is vitally important — without an emergency fund, your financial wellness could be at risk.
Unexpected expenses may force you to take on debt or miss payments, creating additional financial stress in the process. It's important to note that an emergency fund differs from a rainy day fund, which is money often used for splurges. On the other hand, emergency funds are reserved for emergencies and designed to keep you out of a financial crisis.
Emergency fund uses
Hopefully, you can avoid unexpected expenses. But if you encounter a sudden financial need, your emergency fund can help. Here are some things that you might use an emergency fund for:
- Home repairs: A flooded bathroom or broken window may not have been in your budget. But an emergency fund can help you tackle surprise home repairs without having to take on new debt.
- Job loss: You can lean on an emergency fund to help pay for your living expenses if you suddenly lose your income. Tap into your cash reserve to pay for rent, utilities and food, while you job hunt.
- Car repairs: The cost of car repairs can come as a shock, especially if you weren't planning on them. Use an emergency fund to take the edge off of unexpected car issues.
- Medical bills: Fifty percent of Americans have medical debt from hospital stays, diagnostic tests and emergency room visits. A cash reserve can keep medical debt at bay.
- Pet emergencies: A sudden illness or injury can send your beloved pet to the vet and incur hundreds or thousands of dollars in bills. A contingency fund gives you the means to handle pet emergencies and keep your furry friend healthy.
These are just some of the unexpected events that would merit tapping into an emergency fund. Several other instances can also catch your finances by surprise and make you grateful for an emergency fund.
How to set up an emergency fund
When it comes to setting up an emergency fund, it's always better to start sooner than later. Once you've started saving, you can build your fund and lower any stress or anxiety about a potential financial emergency. Here's how to get started:
- Determine where to keep an emergency fund
- Create a goal emergency fund amount
- Start and continue to build your emergency fund
Decide where to keep an emergency fund
There are many different savings accounts to consider for an emergency fund, each offering various benefits. Broadly speaking, you'll want a savings vehicle that provides easy access to your funds, along with the assurance that you won't lose them.
Some options for your emergency fund include:
- Traditional savings accounts provide immediate access to your money and offer the opportunity to earn a nominal amount of interest.
- CDs offer a higher interest rate but also often come with minimums and penalties for early withdrawals.
- Money market accounts are similar to CDs in that they provide higher interest rates but they also offer debit capabilities while sometimes requiring larger account minimums.
As you begin to build your emergency fund, weigh the benefits of each option and find the one that fits your needs. For instance, you may choose a traditional savings account connected to your checking account because your emergency funds are easy to access. Or you may opt for a high-yield savings account to earn more from the money you're stashing away.
Determine how much should you have in an emergency fund
The amount of money you save in an emergency fund will be specific to your needs, income and expenses. The goal will vary from person to person and family to family. That said, there are guidelines to help you save money. For example:
- Start with a small amount. Saving $250 or $500 gives your emergency fund a boost out of the gate. You don't need to have a big windfall to begin; instead, set aside a small amount that works with your budget.
- Aim for three months' worth of expenses. Many financial advisors recommend a minimum of three months' worth of expenses as a rule of thumb for how much you should save.
- Move toward saving half a year's worth of living expenses. Once you've achieved three months' worth of savings, set a new goal of six months to build out an even bigger safety net.
- Choose a percentage of your income. Accelerate your savings by designating a certain percentage of your income to your emergency fund. For example, you might set aside 5% or 10% of each paycheck.
- Pick a dollar amount per day to contribute. Alternatively, you could ramp up your savings efforts by deciding to save a specific amount each day. Contributing $5 daily to your emergency fund can yield significant savings over time.
These guidelines can help you get your emergency fund going. But they're not hard and fast rules. The best way to save money is any way that enables you to save consistently and works in conjunction with your financial circumstances.
Grow your emergency fund
Once you start saving for an emergency fund, you want to keep the effort going. Employ a few of these tips for building your emergency savings, and your personal finance situation will benefit:
- Set up direct deposit into the emergency fund account. By making your savings automatic, you can help ensure it happens. Dedicate a specific amount to automatically transfer from your checking account to your emergency fund account each month.
- Set aside unexpected income. An inheritance, work bonus or even prize money can give your emergency fund a big boost. Save unexpected income, and you'll reach your emergency fund goal that much sooner.
- Put your money to work. Help yourself by saving your emergency fund in an account that pays you back. From savings accounts to money market accounts, look for ways to earn interest off your savings and grow your emergency fund that much faster.
- Keep in touch with your savings goals. Track how much you are saving and the growth of your emergency fund. Adjust your goals as your circumstances change, and celebrate when you reach a savings milestone.
An emergency fund can provide you with a sense of safety and financial security in preparing for the future. That way, if you face unexpected expenses, you'll have a cash reserve to rely on instead of debt or credit. Building an emergency fund also allows you to practice saving for financial goals and create healthy money habits.
Connect with a banker if you need help determining where to keep your emergency fund or how much to save. A banker can also help you establish attainable goals that make your emergency savings a success.
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