Your emergency fund: The essential guide

We all experience costly, unplanned expenses from time to time—a broken appliance, an auto accident, a surprise medical bill, a loss of income. Having a dedicated emergency fund can not only provide the reassurance you’ll be able to meet unanticipated financial needs, but it’s also one of the first essential steps you can take to start saving. Putting even a small amount aside for emergencies can help you recover more quickly and get back to meeting your financial goals that much faster.

In this guide, we’ll explain how to build your emergency fund, how much money to save in your emergency fund, where to put your emergency savings, and when to tap into it.

What is an emergency fund?

An emergency fund is a dedicated savings account specifically set up as a cash reserve to cover unplanned expenses and financial emergencies. Some common reasons for tapping into these funds include unexpected medical bills, car and home repairs, or job loss.

Generally, emergency savings can be used for any unforeseen bills or payments not part of your routine monthly expenses and spending. Emergency savings differ from savings set aside for leisure travel, holiday gifts, down payment for a home or car, and other large expenses which are typically planned for ahead of time.

Why do you need emergency savings?

Without savings, a financial setback could turn into debt and potentially have a lasting impact on your financial outlook. Relying on credit cards, loans, or other savings, like retirement accounts, to cover emergency expenses can lead to debt that may be hard to pay off, or decrease your future financial security.

Emergency savings can pay for unplanned or emergency costs and spending outside of your otherwise routine monthly bills and expenses. For example:

• Home repairs: A leaky roof can cause additional damage to your home, ultimately costing you more money; a broken appliance, like a furnace or water heater, typically requires
  immediate repair.

• Car repairs: If you’re in an auto accident and need your car to get to work or school, delaying major repairs isn’t an option.

• Medical bills: Surgery, a hospital stay, or a major illness could cost you thousands of dollars, even if your health insurance covers part of the bill.

• Loss of income: If your wages or hours are cut, or you are laid off, an emergency fund can help you pay essential bills.

How much money should you keep in your emergency fund?

The amount of money you have in emergency savings will vary depending on your income, the rate at which you’re able to save money, and your other financial obligations. Being laid off would be a major financial emergency for most people. To cushion against this, experts generally advise saving enough in your emergency fund to cover between three to six months of your essential living expenses.

You might need to save more than this if:

• You’re the sole earner, with dependents, in your household

• You’re an independent contractor or freelancer with variable monthly income

• You’re working in an industry prone to layoffs

Essential living expenses generally exclude discretionary spending such as streaming subscriptions, new clothes, tickets to sporting events or concerts, travel, or dining out. Essential expenses are the bills you must pay every month, such as:

• Rent or mortgage payment

• Debt payments (car payment, student loan payment, minimum payments on credit cards)

• Groceries

• Utilities

• Childcare or tuition

• Insurance premiums

How do you build an emergency fund?

Depending on your current income and debts, setting aside three to six months' worth of living expenses into an emergency savings account could be challenging at first, especially if you’re already on a tight budget.

To build some momentum for saving, start by setting a small savings goal you can easily reach and increase your goal amount as you progress. For example, what was the last unplanned expense you had difficulty paying? If paying a $300 dental bill was a struggle before, set an initial emergency fund goal of $300. Once you reach that goal, set a bigger goal, and so on.

Next, examine your current budget (or create a budget if you don’t have one) and spending habits to find areas where you can cut back. Put that money toward your emergency fund. Some expenses to consider forgoing for a while might include entertainment (restaurants, concerts, sporting events), subscriptions (streaming services, wine or food delivery memberships), and travel.

Squeezing extra money out of your budget isn’t the only way to build your emergency fund. You can also try:

• Using “found money”: Whenever you get an unexpected windfall, such as a tax refund, stimulus payment or cash for a birthday gift, put it into your emergency fund.

• Redirecting loan payments: Once a loan is paid off—for instance, a car loan, student loan or credit card balance—you could redirect the amount you previously put toward that bill each month into your emergency savings.

• Banking your bonus money: If you get a raise or earn a bonus, keep living on your previous income and stash the difference in your emergency savings.

• Earning more: Starting a side job or gig—selling items you no longer need or use, driving for a ride-share service, working retail during the holidays—can all jump-start your emergency savings.

• Looking for cash-back opportunities: Turn your credit card rewards points into cash back and put those savings into your emergency fund.

Automating your savings can help you build your emergency fund. For example, you could schedule an automatic transfer from your checking account to your savings account right after you get paid. Some employers could directly deposit your paycheck into two different bank accounts. This keeps the money from hitting your checking account, so you won’t be tempted to spend it.

If you’re a freelancer or have inconsistent income, instead of automating transfers (which may leave your checking account short of funds), you might try designating a certain percentage of every deposit—say, 5% or 10%—into your emergency fund.

Where should you keep your emergency savings?

When choosing the type of account for your emergency funds, consider easy-to-access, interest-bearing savings or checking accounts. Generally, unless there are additional associated fees, the account should be separate from your already established accounts, such as a vacation savings account or a regular checking account used to pay your monthly bills.

Earning interest on your emergency savings is another important consideration, and the type of account you choose can affect those earnings. Generally, high-yield savings accounts or money market accounts offer a higher annual percentage yield (APY) than regular savings accounts. These types of accounts typically are also easy to access when you need to make a withdrawal.

However, depending on your financial habits, it might be helpful if your emergency funds are not too easy to get to. To create some friction, consider establishing an account at a different bank than where you have your regular checking or savings accounts. Confirm how long it takes to transfer money from one bank to another in case you need to withdraw funds quickly.

Before selecting the type of account for your emergency savings, be sure you know the answers to the following questions:

• Is this an interest-bearing or high-yield account?

• What is the APY, and how does it compare to similar accounts?

• Is there a minimum account opening deposit or monthly balance requirement?

• Can you easily transfer funds between bank accounts? How long do fund transfers take?

• What are the associated fees, and how are they applied?

• Is the financial institution insured? Look for banks insured by the Federal Deposit Insurance Corporation (FDIC), and credit unions insured by the National Credit Union Administration (NCUA). This protection means your deposits are insured up to the maximum amount allowed — $250,000 per depositor for each ownership category.

How should you use your emergency savings?

Reserving your emergency fund withdrawals for only urgent, unforeseeable expenses is essential. Set some realistic, consistent guidelines. Not every unplanned expense will be an emergency, but don’t be afraid to tap the funds should you need to. For example, when paying now for preventative measures on your home or car will help you avoid more costly repairs or replacements in the future. Also, having emergency savings can help you avoid relying on high-interest credit cards or other forms of credit that may lead to debt and cost you more in interest and fees over time.

As your emergency savings grow, it may be tempting to tap these funds for non-urgent, discretionary expenses and spending, such as a down payment on a new car. Instead, plan ahead to save separately for this and other financial goals by setting up or designating different savings accounts for different purposes.

Should you pay off debt or build an emergency fund?

If you’ve accumulated revolving high-interest credit card balances or other debt, is it better to pay down that debt first before putting money into emergency savings? While the average interest charged on outstanding credit card balances far outweighs the interest you can earn on the average high-yield savings account, without an emergency fund, it could push your credit card balance (and cost of borrowing) even higher, and possible at higher rates.

Generally, it’s helpful if you can allocate some money toward debt repayment, and some—even if it’s a small amount—toward establishing emergency savings. As you begin paying down your credit cards, you could start to accelerate your savings by redirecting the money you previously put toward credit card debt toward your emergency fund.

The bottom line

Setting aside at least three to six months of essential living expenses into an interest-bearing savings or checking account for unplanned financial emergencies is an important first step toward saving. Even if you’re already on a tight budget, setting aside even a small amount into an emergency fund can help you recover more quickly, help you avoid more credit card debt, and get back to meeting your financial goals that much faster.