What Is An Emergency Fund? - MagnifyMoney

What Is an Emergency Fund and How Can You Start One?

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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.

Key takeaways

  • An emergency fund is a safety net reserved for unexpected expenses.
  • Experts recommend saving three to six months’ worth of living expenses in an emergency fund.
  • An emergency fund is best kept in a secure account that allows you easy access to your cash.
  • Pay down your high-interest debt first so you can contribute more to an emergency fund.

What is an emergency fund?

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:

  • Sudden medical bills
  • Necessary home or car repairs
  • Living expenses after a divorce, job loss or other major life event
  • Unexpected but necessary travel

Why should you have an emergency fund?

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.

Remember it like this: You hope you never have to use your emergency fund — but it’ll be there if you need it.

How to start an emergency fund

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.

1. Determine your emergency fund amount

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?

2. Start saving your emergency fund

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.

3. Decide where to keep your emergency fund

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.

  • Checking accounts: Quick access to your funds via checks, debit cards or online transfers. You’ll typically earn low, if any, interest on your balance. Checking accounts will generally have the fewest transaction limits of any accounts on this list, making them convenient in the case of sudden withdrawals.
  • Cash management accounts: Quick access to cash via checks, debit cards or online transfers, and you may earn a higher APY on your balance. Check out our current roundup of the best cash management accounts.
  • Savings accounts: Not as accessible as checking accounts or money market accounts, though they offer higher APY on your balance. Review our roundup of the best savings accounts for various goals.
  • Money market accounts: Quick access to cash via checks or online transfers (and sometimes debit cards). You may earn a higher APY on your balance, though your balance may have to reach a certain threshold. See which money market accounts are offering the best rates.
  • CDs: Limited access to cash due to early withdrawal penalties. Instead, you could use a no-penalty CD (lower interest rates, but with more withdrawal options) or build a CD ladder (opening CDs of different terms, increasing your liquidity, though only slightly).
  • Prepaid debit cards: Ready to use in an emergency, which can be convenient. These can also be covered by FDIC insurance under certain circumstances. Compare options in our roundup of the best prepaid debit cards.

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.

4. Automate your saving process

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.

5. Monitor your emergency savings

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.

Emergency savings tips

Your emergency fund contributions can take different forms. Here are some ways to expedite and make the most of your savings process:

  • Look for bonus offers: Take advantage of checking account bonus offers and savings account bonus offers. They could be a quick win for your emergency fund.
  • Cash back apps: Cash back apps, like Ibotta or Rakuten, may not be your thing, but they can be a good way to get rebates, discounts or rewards for making certain purchases.
  • Save unexpected income: When you receive a credit from a retailer or a cash gift from a family member, consider adding this lump sum to your emergency savings.
  • Save your tax refund: In 2021, 41% of consumers planned to put their tax refund into savings, according to a MagnifyMoney survey.
  • Rearrange your bill due dates: This may not get you more cash, but it could help ease your stress and make it clearer where saving is possible throughout the month.
  • Avoid account fees: When opening any type of account, ask questions and read the fine print in disclosures, so you can make sure you’re not about to pay unnecessary monthly fees (money that could otherwise go to your emergency fund).
  • Pay down debt: Your emergency fund is a priority, but if you’re accruing debt and already have a high debt load, make it a goal to pay that down first. Avoid paying all that interest you would otherwise accrue, and soon you’ll be free to contribute more to your emergency savings.
  • Sell your stuff: If you want to make a dent in your emergency fund right away, selling a few items could give you a nice head start.
  • Know when to get help: If you’ve tried saving and still feel stuck, there are some places you can get free financial advice. Otherwise, consider reading our guide to choosing a financial advisor. A financial advisor can narrow down your savings options with more expertise.

When to use your emergency fund

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.

Frequently asked questions

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.

Most financial experts recommend that you save three to six months worth of living expenses. However, you can start by contributing as little as $5 a month and increase that over time.
You want your cash to be secure and also accessible to you. That leaves options like checking accounts, savings accounts, money market accounts and cash management accounts.
Use your emergency fund only in the event of a serious, unexpected and costly life event, like a car accident, major home repair or job loss.

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.