Emergencies seem to wait for the most inopportune time to strike. Even with $1,000 saved, you may have a tough time weathering a financial emergency that lasts longer than a month. But the 24% of Americans with zero dollars set aside are the most financially vulnerable.
If you have little to no savings, now is the time to start an emergency fund to protect your livelihood in the future. Below are 8 steps to help you grow a healthy emergency fund.
- What Is an Emergency Fund?
- How To Build an Emergency Fund
- Who Needs an Emergency Fund?
- How Much Money Should You Keep in Your Emergency Fund?
- Where To Keep Your Emergency Fund
- Final Thoughts
What Is an Emergency Fund?
Disaster comes in many forms. Sometimes it’s a job loss, medical emergency, vehicle or home damage, or even a global pandemic. An emergency fund is a stash of money that helps you ride out the disaster for three to six months. It’s a safety net you use to continue to pay your bills until the crisis has subsided.
An emergency fund is usually set aside in its own account to avoid using it unless it's a true emergency. Having this money can protect you from falling into high-interest debt. For example, from credit cards or loans.
How To Build an Emergency Fund
Building an emergency fund can feel like a Herculean task. Especially if you feel stretched thin with the high cost of inflation and housing.
But commitment, a methodical approach, and the right tools can pave the way to building your fund. Once you’ve set up a system that works, your savings can grow with little thought or intervention on your end.
1. Create a budget
There’s no way around it. Tracking your income and expenses is a must before figuring out how much you can allocate to a savings fund. The easiest way to do it these days is with a budgeting app.
The right budgeting app can also help you discover areas where you’re overspending. For example, you may be paying $12 a month for a subscription you no longer use or need. Canceling that subscription can allow you to save $144 extra per year.
Budgeting apps also use visuals to track your progress as you work toward your savings goals. This allows you to watch your emergency fund grow and can encourage you to keep saving.
2. Open a high-yield savings account
An emergency fund should (hopefully) sit for a while before you need to tap into it. It makes sense to park this stash somewhere with minimal risk and some interest return. A high yield savings account can offer high interest rates with no fees and a low minimum deposit to open.
As the Fed continues to hike up the benchmark interest rate, savers are finally seeing higher yields on savings accounts. Now is the time to stretch your savings further by taking advantage of these higher rates.
Finra also advises opening a high-yield savings account specifically for your emergency fund. A separate account for your savings can keep you from spending your emergency money on other expenses. Keep in mind, while savings accounts are liquid, you can only make a limited number of withdrawals. Usually, it's six withdrawals per month before you’ll pay a penalty.
3. Start small
A cushioned emergency fund doesn’t happen overnight. It’s a series of small, consistent contributions over time. Your budget may reveal that your finances are too tight to contribute to savings. If that's the case, you want to consider a microsavings app.
In the true spirit of penny-pinching, microsavings apps save your spare change. When you make a purchase, a microsavings app can round up the cost to the nearest dollar. Then, it can send the difference to a savings account.
For example, if you buy a coffee for for $5.50, a microsavings app can round up the purchase to $6 and send $.50 to your savings. If you're thinking $.50 isn't worth saving, consider this next example.
Say you make five purchases per day and each one sends $.50 to your savings. That's $2.50 per day, $75 after 30 days, and $900 a year. So saving your spare change is a helpful way you can start saving with little financial impact to your everyday life.
4. Set automatic deposits
A popular personal finance strategy is to “pay yourself first.” This doesn’t mean shopping for yourself first. Rather, pay your future self by contributing to your savings when you get paid.
Setting up automatic payments is a gret way to pay yourself first. Some employers even allow you to send a portion of your paycheck directly into a savings account. This eliminates the temptation to spend it if it's sitting in your checking account.
5. Pay down your debt
According to a recent survey, about 55% of Americans have no emergency savings. This same group of people also have no available credit. Some maxed out their credit cards while others don't own a credit card.
This common financial predicament begs the question, where should your money go first? Should you pay down your debt or building an emergency savings fund first?
Taking care of both, even if slowly, is important to overall financial wellbeing. For example, say you choose only to pay down your debt and a crisis strikes. You may end up accessing credit again and paying interest on that emergency expense.
Having some money growing in emergency savings is better than nothing. And, as you pay off credit card debt, you can redirect freed up money to grow your emergency fund even faster.
There are budgeting plans that take a balanced approach to reduce debt while saving. The 50/30/20 budget is a good example. This budget suggests spending 50% of your income on necessary expenses. This includes any minimum credit card payments. And 30% of your income can go toward wants. Your wants include any extras like vacations and streaming services.
The remaining 20% of your income is for savings and paying down debt. And you can divide the 20% how you see fit. For example, saving 10% of your income and using 10% to pay down debt. Or, saving 15% of your income and using 5% to pay down debt.
6. Track your progress
Building your emergency fund is a marathon endeavor. It takes patience, but tracking your progress can be exciting. In addition to a budgeting app, consider using a tool like Empower.
Empower isn't a budgeting app. Instead, it offers a variety of free tools to help you track your overall financial well-being. Empower can suggest a reasonable emergency fund goal and track your progress. When you connect all your accounts to Empower, you can also keep track of your net worth.
Again, seeing your progress can motivate you to stick to your savings habit. Also, celebrating with small rewards along the way (that don’t put you back in debt) can also inspire you to keep saving.
7. Save your windfalls
The average 2022 refund is $2,323, up 22.3% from last year, according to the IRS. Instead of spending that money, send it to your emergency fund.
A couple extra thousand bucks is one of the fastest ways to start an emergency fund or to fatten up an existing one. Other windfalls like inheritances, or selling your possessions can also boost your savings. It’s wise to pair these windfalls with a steady savings contribution plan.
8. Save your cash back rewards
If you use a cash back credit card for your everyday spending, think about saving your rewards. The right cash back credit card could add hundreds to your emergency savings fund per year.
For example, the Blue Cash Preferred Card from American Express offers 6% cash back on supermarket purchases, up to $6,000 per year. If you spend $200 on groceries per week, you can get up to $48 in cash back in a month. And that's just on groceries. The Blue Cash Preferred Card also offers 3% cash back on gas. That's another big spending category for many Americans.
However, the Blue Cash Preferred Card does come with an annual fee. If you don't take full advantage of all the rewards and perks, it's not worth it. Check out our full list of the best cash back credit cards to find the one that fits your lifestyle best.
Who Needs an Emergency Fund?
Since no one is exempt from unforeseen emergencies, everyone needs an emergency fund. In the last 12 months, 20% of adults experienced unforeseen medical expenses with a median cost of $1,000 to $1,999.
Expenses like these are trouble for anyone without an emergency fund. Even if you do have $1,000 saved, one emergency could entirely wipe out your savings.
The question is not if, but when these costly crises might strike. A healthy emergency fund is essential to help protect you from financial ruin.
How Much Money Should You Keep in Your Emergency Fund?
The exact dollar amount that you’ll need to have in your emergency fund will depend on your situation. The standard advice is to save three to six months’ worth of your nonnegotiable expenses (not your income). Consider the following when determining how much to save in your emergency fund:
- How much do your necessary expenses total for one month?
- Do you have people who depend on your income?
- How much have you paid in the past for unforeseen emergency expenses (medical bills, transmission going out on the vehicle, roof replacement etc.)?
- Do you have a backup income plan if you face sudden job loss?
Also, check out our emergency fund calculator to help you figure out how much money you should be saving.
Where To Keep Your Emergency Fund
It makes the most sense to place your emergency fund in a high-yield savings account. This allows you to access your money in case of an emergency. And your savings can grow with virtually no risk.
You’ll find the best savings account interest rates from online banks. Select one with no fees and a low minimum deposit. Our list of best savings accounts breaks down the APY, fees, and minimum deposits so you can choose the best one for you.
How long does it take to build an emergency fund?
Those who make small but regular contributions to their savings fund may need to wait a couple of years to see a few months’ worth of expenses in their emergency savings. For example, sending $100/month to an emergency fund for two years would yield $2,400 without interest. But, adding windfall payments like tax returns would significantly slash that timeframe.
How much money should I save every month?
Our emergency fund calculator can take a look at your financial and employment situation and figure out an emergency fund estimation for you. If you’d like to meet that emergency fund savings goal within a year, take your total emergency fund goal and divide by 12. That’s the dollar amount that you should put into your emergency fund.
If your financial situation has less room to spare, then consider the 50/30/20 budget, which puts a percentage of your income toward savings instead of a set dollar amount.
When should you use your emergency fund?
Any necessary financial obligation that’s not budgeted for is likely a good use for your emergency fund. These scenarios might include:
- Health emergencies for yourself or a loved one
- Vehicle repair
- Necessary home repair
- Job loss
You worked to create your emergency fund safety net, so use it in times of need and resist the urge to reach for a credit card.
Emergency funds are a necessary component of your overall financial health. When the unexpected happens, your emergency fund can be your safety net until you get back on your feet.
Many people start their emergency fund from zero, and that’s OK. With a sound financial plan and a little patience, anyone can create a healthy emergency fund.