Life is full of unpredictable events that can throw carefully laid plans into complete disorder. Many Americans are dealing with this reality as the current crisis unfolds in the United States and around the world.
When you experience a serious disruption to your livelihood, such as the loss of your job, prolonged illness, or injury from an accident, it’s crucial to have money set aside to manage the financial impact of such events. That’s where an emergency fund comes into play.
Find out how much you should squirrel away depending on your financial situation, effective strategies for saving enough money, and where to put your emergency fund:
- What Is an Emergency Fund?
- How To Build an Emergency Fund
- Where To Save Your Emergency Fund
- If You’re in a Financial Emergency Right Now …
- The Bottom Line
What Is an Emergency Fund?
An emergency fund is meant to cover the bills during times of significant financial loss, like when you’re facing unemployment or serious illness. In this way, an emergency savings fund is different from a long-term savings plan for goals such as retirement, college, or a vehicle purchase.
“It is not where you put money you want to use to take a vacation, go shopping, purchase a house, or any other expense that falls into the ‘want’ category,” says Lauren Bringle Jackson, an accredited financial counselor and content marketing manager at Self, a financial technology company based in Austin, Texas, that aims to help people build credit.
An emergency fund is also different from a rainy day fund, which is geared toward smaller unforeseen expenses that are typically one-offs, like repairs for a household appliance or medical care for a pet. Your emergency fund should be much larger than your rainy day fund. Later on, we show you how to calculate an appropriate emergency fund amount for your financial situation.
Why do you need an emergency fund?
It’s important to have an emergency savings fund because good conditions — no matter how calm or stable they seem — might not stay that way forever. By building a cash reserve, you’ll give yourself some financial protection when the unexpected strikes.
For many Americans, the coronavirus pandemic is driving this point home. Reflecting nationwide efforts to contain the COVID-19 outbreak, the unemployment rate soared to 14.7% in April 2020, according to the Bureau of Labor Statistics — the highest level since the Great Depression.
“Having an emergency savings can turn a financial emergency into an inconvenience,” Jackson says. “It can prevent you from having to borrow money and go deeper into debt, or at least reduce the amount you need to borrow. It could protect you from having to make a hard financial choice or having to make sacrifices to afford an emergency.”
Funds stored away for emergencies can serve multiple purposes. However, the most commonly cited reason to build an emergency fund is enabling people to pay their monthly bills if they lose their job, says Timothy Wiedman, a retired associate professor of management and human resources at Doane University in Crete, Nebraska.
An emergency fund works as a financial safety net to keep you covered when you’re no longer bringing in income. How big that safety net needs to be depends on several factors.
How much should you have in emergency savings?
The emergency fund amount that’s right for your situation is heavily influenced by your cost of living. Your target goal should be shaped by various essential expenditures, such as what you pay in rent each month and how much you spend on groceries and gas for your car.
“At an absolute minimum, the fund should cover three months of recurring expenses,” Wiedman says.
Three to six months’ worth of expenses is one of the most frequently used rules of thumb for an emergency fund. What’s important is calculating the costs you’ll need to plan for. According to Wiedman, these recurring living expenses include:
- Housing costs — i.e., rent or mortgage payments
- Groceries
- Utilities, including internet access and cellular service
- Transportation-related costs, such as monthly car payments or routine maintenance
- Insurance payments, such as premiums for health, life, auto, homeowners, and renters coverage
- Co-pays for health care appointments and prescription drugs
Your income also factors into the specific dollar amount you should save in your emergency fund. In general, the amount that a lower-income household needs and can save is likely different from the amount that a higher-income household requires for coverage during emergencies.
With the help of data from the Bureau of Labor Statistics, you can get an idea of how much different households should aim to save in an emergency savings fund to cover three to six months’ worth of living expenses. These figures come from national averages, so the amount that you personally need to save will vary, especially since your cost of living is heavily dependent on geographic location.
Based on the necessary expenditures singled out by Wiedman as well as consumer spending data covering July 2018 through June 2019, sourced from the agency’s Consumer Expenditure Survey, this is how average living costs break down by household income level:
| Household Income | Average (Mean) Annual Expenditures on Necessities | Monthly Expenditures | Cost of Living for Three Months | Cost of Living for Six Months |
|---|---|---|---|---|
| All Households | $43,475 | $3,623 | $10,869 | $21,738 |
| Less than $15,000 | $18,314 | $1,526 | $4,579 | $9,157 |
| $15,000 to $29,999 | $24,239 | $2,020 | $6,060 | $12,120 |
| $30,000 to $39,999 | $29,374 | $2,448 | $7,344 | $14,687 |
| $40,000 to $49,999 | $33,068 | $2,756 | $8,267 | $16,534 |
| $50,000 to $69,999 | $38,439 | $3,203 | $9,610 | $19,220 |
| $70,000 to $99,999 | $47,078 | $3,923 | $11,770 | $23,539 |
| $100,000 to $149,999 | $60,019 | $5,002 | $15,005 | $30,010 |
| $150,000 to $199,999 | $75,742 | $6,312 | $18,936 | $37,871 |
| $200,000 and more | $105,591 | $8,799 | $26,398 | $52,796 |
How to prioritize saving for an emergency fund
It can be confusing to figure out how to fit saving for emergencies into your financial priorities. For example, is it more important to create an emergency fund or pay down debt? Does saving for an emergency come before saving for retirement?
“First and foremost, before putting together an emergency fund, you should always prioritize designating any additional savings you have towards paying down debt — most specifically high-interest credit card debt,” says Adem Selita, CEO at The Debt Relief Company, a financial services company based in New York City that specializes in debt relief programs. “In order to do this, you should evaluate the opportunity cost of your money. Your money is not working for you in the best possible manner if you are accruing 1% interest in savings and paying 20% interest in debt.”
Eliminating high-interest debt is an important early step in building your emergency fund because it enables you to save more effectively. Once your pressing debts are out of the way, your next goal should be saving for your emergency fund. Contributing to your retirement generally takes priority after saving for an emergency, but there are exceptions. If you have a 401(k) plan, for example, it might be worth simultaneously saving for retirement while eliminating debt or building your emergency fund.
“In general, contribute to retirement savings once the emergency fund is solid,” says Sean Fox, co-president and chief revenue officer of Freedom Financial Network, a debt relief company based in San Mateo, California. “However, if you’re working for an employer with a matching program, not participating is like giving money away. If at all possible, contribute — even a small amount — to such a plan while paying down credit card debt.”
In short, you can distribute your funds in this order to try making the most of your money:
- Eliminate high-interest debt.
- Build your emergency savings fund.
- Save money in your retirement fund. If you have a 401(k) plan with an employer match, it’s smart to tackle the first two steps while saving simultaneously for retirement.
- Set aside money for other financial goals.
How To Build an Emergency Fund
Slow and steady is the name of the game. Here’s a look at some effective tips for growing your emergency savings fund.
1. Save part of each paycheck
One of the most basic strategies to build an emergency fund is putting a percentage of each paycheck toward your savings. The percentage is ultimately up to you, but no matter what you choose, it means you’ll build your emergency fund every time you get paid. This can help you stay consistent instead of choosing random times and fluctuating amounts of money to save in your emergency fund.
“If you’re just starting out, put at least $100 in savings for every paycheck. If you get paid twice a month, that’s $2,400 per year,” says Michael Bonebright, a senior blog editor and consumer analyst at DealNews, a coupon and deals website based in New York City. “That may not sound like much, but it’ll cover the cost of replacing your car’s transmission, for example.”
If you already have some emergency savings, then putting away at least 20% of your income is a good rule of thumb going forward, says Howard Dvorkin, a certified public accountant and chairman of Debt.com, a financial education company based in Plantation, Florida, that connects people with debt solutions.
Depending on how quickly you want to reach your savings goal, you might increase your contribution per paycheck over time, similar to what’s often recommended with retirement savings. This decision is ultimately up to your personal preference and financial situation.
2. Set up automatic savings
Automating your savings helps you build your emergency fund on a consistent basis without having to make manual transfers. It’s an easy way to steadily grow any sort of savings fund, whether it’s for a big vacation, retirement, or an emergency. By taking yourself out of the picture, you can rein in any inclinations to spend the money that should be going toward your savings.
You can automate your emergency fund savings through your bank if you receive your paycheck as a direct deposit. You can also contact the human resources department at your company and set up automatic payroll deductions into an account of your choice.
3. Put windfalls toward savings
When you receive a tax refund or a bonus, you might feel the urge to spend it immediately on something nice. After all, it’s just extra money, right?
However, saving part or all of your windfalls can help you build an emergency fund faster than just putting away small portions of your paycheck. Consider resisting the lure of your shopping cart and get used to putting additional money toward your savings instead.
4. Adjust your withholding
If you’re not an independent contractor, you can adjust your tax withholding by filing a revised Form W-4 with your employer. By reducing how much is withheld from each paycheck in taxes, you’ll get more money per pay period to put in your own pocket. You can then put those funds into your savings account, where it’ll earn interest.
Claiming more allowances will affect the size of your tax refund, so make sure to weigh the benefits and consequences of adjusting your W-4 form to build your emergency fund.
5. Review your monthly spending
Evaluating your expenses and identifying wasteful spending can help you find money to put toward your emergency fund. To review your monthly expenses, look at your credit card statements and bank account’s transaction history — namely, purchases made through a debit card or by withdrawing cash.
“Take a look at what you spent your money on in the last 30 days, line by line, and break it down into categories such as eating out, shopping, utilities, subscriptions, etc.,” Jackson says. “Are there any obvious categories you can cut back on? If so, cut your spending on those categories first, and redirect that money towards your savings instead.”
You should get more granular during this evaluation to determine what constitutes waste, Jackson says, and compare use vs. cost. For example, if you spend on monthly subscription services, examine how many subscriptions you have versus how often you actually use them. You may even find recurring payments for subscriptions that you forgot you had.
What’s more, you can reduce spending on utilities by lowering your energy consumption through basic steps, like buying energy-efficient lightbulbs and unplugging appliances when they’re not in use. Another way to cut down on your utility costs and other monthly expenses is to contact your phone, energy, water, and insurance companies and negotiate better rates, Dvorkin says.
Where To Save Your Emergency Fund
Generally, you’ll want to save your emergency fund in a bank account rather than under your mattress or somewhere else in your home. You can earn interest on the money in your bank account, unlike the cash stashed in your drawer. However, there are different benefits to saving your emergency fund in each type of account. We’ll cover high-yield savings accounts, money market accounts, and investment accounts below.
Note that we don’t mention certificates of deposit. This is because your emergency fund should be liquid, or easily accessible. CDs might provide higher interest rates than savings accounts, but they also usually come with early withdrawal penalties, which isn’t ideal for an emergency savings fund.
High-yield savings accounts
Savings accounts are a natural first choice for your emergency fund. However, many of the major brick-and-mortar banks have a fairly low annual percentage yield — or the total amount of interest you can earn over a year — on their regular savings accounts.
High-yield savings accounts, on the other hand, provide better APYs compared to regular savings accounts. You can typically find high-yield savings accounts at online banks, because they don’t face the overhead costs of maintaining a branch network. High-yield savings accounts might also offer tiered interest rates, which means keeping a larger balance unlocks a higher APY — resulting in accelerated savings for your emergency fund.
Money market accounts
An insured money market account is typically what you want to use for an emergency fund, according to Mike Sullivan, director of education at Take Charge America, which is a nonprofit credit counseling and debt management agency based in Phoenix.
“You want to get some return, but you want the money available quickly in an emergency and you don’t want to risk losing any of it as you might with most investments,” Sullivan says.
Money market accounts combine certain elements of high-yield savings accounts and checking accounts into one product. They generally have higher APYs than standard savings accounts and offer the ability to write checks. Like savings accounts, however, money market accounts are limited to six withdrawals per month, according to the Federal Reserve’s Regulation D requirements.
Investment accounts
While putting your emergency fund in a checking or savings account at a bank is a safe move, the low returns would allow inflation to eat away at your money over time, says Taylor Matthews, founder of Farther, a financial planning and investment management company based in New York City.
“You can get better long-run returns without sacrificing much in terms of volatility by using an investment account instead,” Matthews says. “Investing an emergency fund in a combination of safer, highly liquid assets like government bonds, bonds that protect against inflation, and money market funds is a good way to improve your returns while still having quick access to your money.”
Thanks to online brokerages and mobile apps, you can open an investment account and start investing on your own. However, it’s also smart to consult with a financial advisor if you choose to go this route.
If You’re in a Financial Emergency Right Now …
It’s important to start strategizing, not panicking. If you already have an emergency fund, now would be the natural time to use it. Try to also limit discretionary spending, aka nonessential expenses like recreation and entertainment. However, a small amount of nonessential spending is OK to keep your spirits up until you’ve found a new job, Wiedman says.
If you don’t have an emergency fund or your savings fall short of your goal, you might need to look into other options, such as financial hardship programs. Many banks and credit unions have financial relief programs, both specifically for the COVID-19 crisis and for more general cases. Some typical financial relief options offered include:
- Waived fees on late or missed payments for credit cards and loans
- Waived early withdrawal penalties for money saved in CDs
- Ability to defer or skip loan payments for a set period of time
There are also government programs that provide financial relief, but you must meet certain requirements to qualify. Besides income limits, other common stipulations include being a senior citizen, living with a disability, or having children in your household who are younger than a certain age.
Here are some key welfare programs that you can check your eligibility for:
- Supplemental Nutrition Assistance Program (SNAP)
- Temporary Assistance for Needy Families (TANF)
- Medicaid
- Children’s Health Insurance Program (CHIP)
You can also mitigate a financial emergency by getting help with your rent and seeking student loan relief. If you’re having trouble paying your bills, remember that aid is likely available to help you through hard times.
The Bottom Line
Pulling together enough money to cover three to six months’ worth of expenses can seem daunting. But the key to building an emergency fund is chipping away at your savings goal. After all, putting money aside consistently is more effective than saving sporadically.
Other strategies to grow your emergency fund include:
- Reduce wasteful spending so you can channel more money into your emergency savings.
- Seek out bank accounts that will maximize your returns.
- Prioritize your debt first so that your emergency fund can be dedicated to your living expenses.
By setting the right savings target for your financial situation and combining these strategies, you’ll be well on your way toward building a viable emergency fund and protecting yourself should disaster strike.
