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How to Build an Emergency Fund
A sound financial planning tactic to handle unexpected expenses without draining your savings.
How to Build an Emergency Fund
A sound financial planning tactic to handle unexpected expenses without draining your savings.
Unforeseen events can turn a financial plan on its head. The risk of something unexpected, like a large medical bill or damage to your property, can sap resources that you use to protect your finances and grow your wealth. Building an emergency fund is an effective way to address unanticipated expenses and improve your financial security.
However, growing an emergency fund isn’t always easy since attempts to do so typically occur when there are conflicting needs for your limited resources. Do you save for an emergency fund or pay student loans? Or credit card bills? Or save for retirement? That may be why just 63% of people said they could cover a $500 unexpected cost in a recent survey.1
Know that the sooner you start building an emergency fund, the sooner you can begin guarding yourself against life’s unforeseen moments.
How much do I save in an emergency fund?
The amount you will want to save in your emergency fund depends in part on the security of your employment or income. Standard advice suggests saving three to six months’ worth of expenses as your emergency fund to prepare for any potential drop or loss of income. If you have $3,000 of expenses made up of rent or mortgage and food, for example, then you would save between $9,000 and $15,000 in your emergency account.
If your job is secured, and you are partnered with someone who also has secured long-term employment, then you can often leave the emergency fund at the three- or four-month mark. If you’re the sole breadwinner or your job has variable income — like if you’re self-employed or a contracted employee — then you might want to push the emergency fund closer to six months.
How do I get started?
All the demands on your monthly income can make it difficult to get an emergency fund started. Not only do you have fixed expenses, like rent or a mortgage, but you also must afford all the other necessities of life, like food or health insurance. On top of that, you may have to repay debt, such as student loans or credit cards.
To get started, you need to determine how much you can afford to direct into an emergency fund each month. Begin by tracking your monthly expenses. Include the minimum payment required on your loans, whether a student loan or credit card balance. How much is left over from your paychecks, after expenses and taxes? Have this money automatically funneled into a savings account, which can be done through your online banking tools.
You will want to build the emergency fund before you begin aggressively paying back your loans. Why? An unexpected expense could increase the amount you’re borrowing and make it more difficult to contribute to your emergency fund. Pay the minimums on your debts, including credit cards, to ensure the balances don’t get out of hand while you build your emergency savings.
Where do I store my emergency funds?
You will want to keep the funds in an account that’s easily accessible, safe, and has the highest possible interest rate for the cash. When inflation is high and interest rates are rising, then the rate of interest you can find in savings accounts will also rise. This allows you to earn a little more cash back from your efforts while the emergency fund sits idle in your savings.
As the interest builds in your emergency fund account, you can shift extra money to help repay loans or use it to pay other expenses (once your emergency fund goal has been reached). Or, if you have to use a portion of your emergency fund to pay for an unexpected bill, then you can begin replenishing the amount with these funds. It’s important to remember that your emergency savings target is an ongoing goal, one that will require you to regrow it once you’ve tapped the funds to cover a surprise.
In terms of types of accounts, standard savings accounts often provide a safe place to store the money since they don’t move up or down (like stocks), and they’re insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000. You may find slightly higher interest rates using short-term certificates of deposit (CD) or a money market account. You don’t want to have the money in an account that locks your funds up for a certain period of time, like long-term CDs, which may charge a penalty for taking the cash out earlier than a stated period (often it’s a year). Ensure the account provides a good rate, and you can easily access the cash when needed.
Without that ease of access, you would lose the whole reason for building the fund: having fast cash to cover an unexpected cost and keep your growing wealth safe. With the right emergency fund in place, you can begin tackling your bigger financial goals and allow your wealth to flourish.
1. Lorie Konish, “63% of workers unable to pay a $500 emergency expense, survey finds. How employers may help change that,” CNBC, August 31, 2023.
