Life doesn’t always go according to plan. Maybe you receive a $1,000 water bill after a small leak goes undetected. Or you take a tumble down the stairs and find your front tooth is mysteriously missing. Or maybe your child decides a popcorn kernel belongs in their ear canal, and you now find yourself in the ER to extract the offending foreign object.
These surprise expenses are a part of life, which is why building an emergency fund is essential. Emergency savings shield you from taking on debt or scrambling to figure out how to pay an unexpected bill when life throws a curveball.
Let’s take a closer look at how an emergency fund can help and why starting one may be easier than you think.
What Is an Emergency Fund?
An emergency fund is a dedicated savings pool set aside to cover unforeseen expenses. Think of it as a rainy-day savings account that you build over time and have readily available when life has other plans.
Whether it’s home repairs, medical bills, or appliance replacements, you can pull from your emergency savings to pay the bill without turning to high-interest credit cards, loans, and other financing. Many emergencies can be covered with less than $1,000. Having at least that amount in the bank helps prevent your budget from being derailed when unexpected bills arise.
How Much Should You Save for an Emergency Fund?
You should have two goals for your emergency fund: save $1,000 as quickly as possible and save three to six months of essential expenses over the long term. Essential expenses are your most basic costs that you can’t do without. Think:
- Groceries
- Insurance premiums
- Utilities
- Rent or mortgages
- Transportation
An emergency savings calculator can help pinpoint your ideal target based on your monthly costs.
Emergency Fund vs. Savings Account: What’s the Difference?
A savings account is a type of bank account, whereas an emergency fund is a savings set aside specifically for unexpected spending. An emergency fund can live in a savings account—or better yet, a high-yield savings account—but its defining feature is that it’s reserved for emergencies only.
You can also put part or most of your emergency savings in other places like:
- No-penalty CDs that let you withdraw money without paying penalties before the CD matures.
- Money market accounts, which generally offer higher interest rates than traditional savings accounts.
Just make sure to always keep at least $500 in a bank account that allows for immediate cash withdrawals or transfers.
Where Not to Keep Your Money
Avoid keeping your emergency fund in your checking account. You want the money to be accessible, but not so much so that it’s too easy to spend accidentally. Also, avoid hiding it under the mattress or elsewhere in your house. You won’t earn any interest to counteract inflation, and you could lose it all in a fire or burglary.
When Should You Use Your Emergency Fund Money?
Your emergency fund is for just that—emergencies. These are expenses that are:
- Unexpected: You couldn’t see it coming.
- Unavoidable: There’s no other option but to pay for it.
- Urgent: You can’t delay paying it.
As an example, a mortgage escrow shortage you have to make up for because of a homeowners insurance premium hike is likely a good use of your emergency fund.
However, expenses related to wear and tear are probably not a good use of your emergency savings. For instance, needing a new car after the one you’ve had for 15 years gives out won’t come as much of a surprise. In this case, it’s better to have a separate car replacement fund that you can build over the years.
As a bonus, your car replacement savings can serve as a second emergency fund. It’s helpful in situations such as when finding a new job takes longer than expected.
Building an Emergency Fund: The Step-by-Step
You don’t need a six-figure salary to start saving for unexpected expenses. As long as your basic needs for food, shelter, and housing are being met, there’s room to contribute to your fund. Here’s a step-by-step guide on how to start an emergency savings.
Step 1: Start Small, Start Now
Even if $5 is all your budget can afford to spare, set aside that money in a separate account and be proud about taking the first step in your journey. The important thing is to start now, not tomorrow or with the next paycheck, and begin building a savings habit.
Step 2: Open a Separate Account
One idea is to open a high-yield savings account for your emergency fund that is linked to your checking account. This is beneficial because fund transfers may be instantly available. Brick-and-mortar banks with a branch nearby are another option that allows for faster access to cash.
As your emergency fund grows, you can consider opening other types of accounts, like CDs with online banks, to get the best interest rates.
Step 3: Commit to Your Savings Goal
The first big commitment you’ll make is to save $1,000 as quickly as possible using some of the money-making strategies outlined in the next step. Once that’s accomplished, you can move at a more reasonable pace as you commit to your next big milestone of saving three to six months of essential expenses.
Step 4: Start Funding Your Account
The easiest way to find money for an emergency fund is to cut unnecessary expenses. Creating a budget can help you identify costs you can reduce or eliminate. You can use Excel worksheets or budgeting apps, such as You Need a Budget, to track where your money is going.
Another solution is to make more money. Some ways to consider include:
- Working overtime
- Freelancing your professional skills
- Being a rideshare or delivery driver
- Decluttering your house and having a garage sale
- Renting out a parking or garage space
Step 5: Keep Making Progress
Setting up recurring automatic transfers helps ensure you prioritize saving and making progress toward your goals. Even if it’s only $20 per week, those small moves lead to a meaningful cushion.
If you receive a pay raise or any cash windfalls, such as a tax refund, consider setting aside at least some of the money toward your emergency fund.
Every Dollar Counts
Building a fully funded emergency fund can take time, and you may find yourself taking two steps forward and one step back when you need to use money to cover an unexpected expense. But that’s not a setback. Your emergency fund is doing precisely what it’s meant to. Keep going and remember, every dollar saved is a dollar you don’t have to borrow.
