Your emergency fund: What it's for and how to build one

In a nutshell

Having an emergency fund can mean the difference between going broke during times of hardship or having a financial cushion to get you back on your feet.

• Having an e-fund puts you in a position to pay for expenses you haven't planned for — situations that might harm you financially if you didn't have extra money stashed away.
• If you're looking for ways to foolproof your finances, a fully stocked emergency fund is a goal you should strive for.

What is an emergency fund?

The term emergency fund is used to describe money you have saved for emergencies that is separate from your checking and savings account. Keeping your e-fund separate from your other assets is crucial since this money is meant to cover unexpected expenses.

While an emergency fund can come in handy in a variety of circumstances, most people build these funds for:

• Unexpected bills, such as a surprise car repair.
• Living expenses in the event of a job loss or loss in income.
• Unplanned medical expenses.
• Sudden onset of disability.
• Unforeseen home repairs.

4 reasons to have an emergency fund

While it would be nice if everyone had an endless supply of cash to spend, reality is not so kind. According to a recent report from LendingClub, more than 60% of the American population was living paycheck-to-paycheck at the end of 2023. Not only that, but a recent survey shows that more than half (56%) of Americans don't have an extra $1,000 to cover a surprise bill.

With such a large percentage of Americans living from hand to mouth, it's easy to see how not having any emergency savings can lead to financial hardship.

Why should every family build up emergency savings? The reasons are varied, but they apply to everyone.

Reason No. 1: You may face a loss in income

While the national unemployment rate stood at just 3.7% as of December 2023, according to the Bureau of Labor Statistics, you could still lose your job or face a loss in income. You may easily find another job, but it often takes a few weeks to begin receiving a paycheck when you do.

In any case, having emergency savings can help you stay on top of bills like your rent or mortgage, your car payment, and utilities while also ensuring you keep food on the table.

Reason No. 2: Surprise repair bills are (unfortunately) the norm

Something is always breaking down — it's just a matter of what and when. For example, owning a home means paying for HVAC repairs and replacement, a new roof every few decades (or even more often), lawn care, and emergency repairs.

The same is true with cars, and the repair bills can mount up quickly when you don't have any extra cash lying around.

Reason No. 3: Life happens

There are dozens of additional reasons to have an e-fund, from unexpected medical bills to unplanned travel for a funeral or taking time off work to care for a loved one.

The fact is, life happens, and the biggest surprises are often very expensive to deal with. An emergency fund can help you weather the storm and stay afloat while you catch back up.

Reason No. 4: Emergency savings can help you sleep better at night

Finally, having emergency savings can bring considerable peace of mind to your life. With a fully stocked emergency fund, you could sleep better at night, knowing you have some extra cash to pay for whatever life throws at you.

In the meantime, an e-fund also ensures you won't wipe out your other savings any time an expected expense pops up.

How much should you save?

The big question is, how much do you actually need to save in an emergency fund? While any amount of savings is better than nothing, there are some general rules of thumb to follow.

For example, budgeting guru Dave Ramsey recommends trying to build up at least $1,000 in emergency savings. Once you're out of debt, then he recommends trying to save up anywhere from three to six months of expenses.

And really, most financial advisors and experts agree that three to six months of expenses is a good goal to shoot for over the long term. After all, $1,000 won't get you very far if you face sudden medical bills or you become partially disabled and cannot work.

With a goal of three to six months of expenses for your e-fund, you can start to visualize how much you need to save. Start by getting out your last few months of bank statements and credit card statements. From there, figure out how much you would need to spend (at a minimum) on expenses like your rent or mortgage, household bills, car payment, insurance, and food.

If you spend $3,000 per month on absolute essentials, for example, your emergency fund should be at least $9,000 and up to $18,000. Since it can take some time to build up that kind of savings, you'll want to work on a strategy that can get you there.

How to build an emergency fund

1. Figure out how much you want to save in your emergency fund: Consider your monthly bills and tolerance for risk. At a minimum, you should try to save up three months of expenses.
2. Determine how much you can save monthly toward your goal: Look for room in your monthly expenses so you can beef up your savings and set a goal.
3. Look for ways to save more each month: Figure out if you can cut areas of your budget in order to increase the amount you save.
4. Automate it: If you're worried, you won't have the discipline to manually transfer money to your emergency fund each month, set up automatic transfers with your bank on payday or any other day of the month that works best for you.
5. Create a long-term goal to reach your ideal emergency fund amount: If you can afford to set aside $300 per month and you're hoping to save up $9,000 in your emergency fund, for example, it will take you 30 months (2.5 years) to get there.
6. Don't let financial mishaps knock you off track: Once again, life happens. If you have to tap into your emergency fund along the way, refuse to let it knock you down and off track.
7. Save your emergency fund for actual emergencies: Leave your money alone unless you absolutely have to use it. A new smartphone or a trip to the Bahamas is not an emergency.

Where should you keep your emergency savings?

Now that you know how an emergency fund works and the steps you can take to build one, you're probably wondering where you should keep this money. There are a few key pieces of information to keep in mind.

First off, your emergency fund should be kept separate from your regular checking and savings account. By never inter-mingling your e-fund with other accounts, you can ensure you don't accidentally tap into this money.

Second, you'll want to keep your emergency fund in a place that is easy to access and an account with little to no risk. After all, you want your money fully liquid if you need it in a true emergency, and you don't want to invest it somewhere it could actually drop in value.

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Generally speaking, the best place to keep your e-fund is in a high-yield savings account, preferably one with the highest possible yield and the lowest fees (or no fees). Also, look for an account that makes it easy to transfer deposits on a monthly basis, either on your own or through automatic deposits.