Difficult and expensive life situations can come out of left field. And because we can’t predict what those will be, we have to prepare for anything. The best way to do that is by having an emergency fund to cover unexpected life events, like losing your salary after a layoff or receiving a sudden hospital bill.
An emergency fund is your key to mitigating financial strain when unplanned expenses come up. Let’s talk about this financial buffer, how it keeps your life on track and how to effectively build one.
An emergency fund is an account where you save money for surprise expenses that can disrupt your life. These savings should be easily accessible to you, so that in the event of an emergency, you’re ready to get the funds you need.
In an emergency fund, you’ll build a nest egg for unplanned expenses like:
An emergency fund allows you to maintain your daily expenses even if an unplanned crisis comes up. It can help you avoid turning a short-term financial emergency into one that affects your finances in the long-term.
With this back-up money readily available, you can avoid turning to riskier, more expensive forms of debt, such as personal loans or credit cards. You’ll also gain peace of mind that you’re prepared for unexpected situations, as well as develop a healthy saving mindset.
Your emergency fund is meant for costly situations that could upend your life if you lack the money to solve them –– not for predictable situations, like home maintenance, your mortgage or your car payment.
Starting an emergency fund is easier said than done –– especially with our current economic backdrop of rising inflation and half of Americans living paycheck to paycheck.
Nearly 24% of consumers report having no emergency savings, according to the 2022 Making Ends Meet survey by the Consumer Financial Protection Bureau. And for those who are saving up for emergencies, 39% have less than a month of income saved (a median of $1,000), while 37% have a month or more saved (a median of $25,000).
But the key is to at least start. Here are steps you can take to actively build your emergency nest egg.
Your emergency fund should generally cover three to six months’ worth of your living expenses, so you can continue to pay for them even in the case of an emergency. Consider your necessary expenses like housing, food, transportation, health care needs, insurance, child care, debt payments, utilities and other regular expenses.
If something came up and your paycheck needed to cover an emergency, how much money would you need to have set aside to cover these necessities?
Begin to set aside the money to cover that three to six months’ worth of living expenses. This may be difficult at first, which is why you should start simple, says Andy Wang, owner and managing partner of New Jersey-based RunnyMede Capital Management and host of the Inspired Money podcast.
“The advice I give to clients at the start of an emergency fund conversation is that you’ve got to start by tracking your spending,” he says. “People get scared away by the budget word. But by simply tracking your spending for one or two months, you can’t help but identify some trends and low-hanging fruit that you can redirect toward your emergency fund.”
Even if that low-hanging fruit is a $10 subscription to a streaming service you rarely use, Wang notes that momentum can be your friend.
“The key is to get started, even if you can only save $5 a month,” he adds. “You start, and as you accumulate more in this account that’s earmarked for emergencies, even if it’s at a slow pace, it gives you something to focus on. Starting small is worthwhile.”
Short-term: Track your spending, solidify a budget and put what you can toward your emergency fund.
Long-term: Most financial experts recommend that you eventually aim for a savings goal of three to six months’ worth of living expenses.
When choosing where to keep your emergency fund, prioritize liquidity (so you can retrieve your money quickly) and security (you should bank with an institution that’s FDIC- or NCUA-insured). When possible, a higher APY (so you can watch your emergency fund grow) is a plus.
Below are some types of accounts where you could store your emergency fund. Be sure to read the fine print of any account to make sure it offers what you need in case of an unexpected expense.
Although you could keep your emergency funds on hand in cash or on a prepaid card, consider an account at a bank or credit union to keep it safe.
Expert tip: It’s generally advisable to not invest your emergency fund. With the uncertainty of investment returns, your emergency fund will fluctuate and you don’t want to be caught with too little money if an emergency pops up.
Consistently and automatically transferring contributions will be the key to building and sticking to an emergency fund. You can set up recurring transfers from one account to your emergency fund, have a portion of your paycheck go directly to your emergency fund or make use of savings tools and features by your bank or credit union.
For example, Wells Fargo offers a savings program called Way2Save®, in which the bank transfers $1 from a linked checking account each time you use your debit card or complete a bill pay transaction through the app. And Bank of America’s Keep the Change® program will round up purchases to the nearest dollar and transfer the difference to your savings.
You can also download automatic savings apps, like Chime, Mint or Digit. They offer budgeting tools, help you set savings goals and allow you to set up those automatic transfers.
Occasionally check in on your emergency fund. You may see more opportunities to save and reach your goal faster. Or, you may decide to slow down, now that you’ve saved up your entire safety net. With a solid six-month emergency fund in place, you could shift your priorities toward other savings goals.
Your emergency fund contributions can take different forms. Here are some ways to expedite and make the most of your savings process:
Use your emergency fund only when faced with a sudden, expensive life event. Ask yourself: Is it unavoidable? True emergencies are unplanned, uncontrollable and materially impact your health, well-being and ability to pay life expenses.
Avoid tapping into this fund for more predictable expenses, like holiday shopping, routine car maintenance or property taxes. And don’t use it for nonessentials, like phone upgrades, expensive vacations and other luxuries.
Leave your emergency funds strictly for the unexpected, rather than your long-term financial goals.
Start by tracking your spending and see what’s leftover each month. Set your overall goal, choose the type of account you want for your emergency fund and start contributing regularly.
It’s generally not a good idea to invest your emergency fund — the returns can be unpredictable, and your funds could drop at a critical time. An emergency fund should be available at all times for last-minute, dire situations.