What Is an Emergency Fund? How to Prepare for Unexpected Expenses

What is an Emergency Savings Fund?

An emergency fund is money set aside for unexpected and unavoidable expenses. This includes medical expenses, home and auto repairs and unemployment.

An emergency fund isn’t a nest egg for other long-term savings goals like buying a home or a retirement fund, and shouldn’t be used for non-discretionary expenses like entertainment or dining out. 

Instead, it’s a financial buffer that hopefully prevents you from taking on high-interest loans and falling into debt. An emergency fund also allows you to save for other goals or grow your money through investing. 

How Much Emergency Fund Should I Have?

“For an emergency fund, the general rule of thumb is to save somewhere between three to six months of essential expenses,” says Matt Gromada, managing director and head of family banking at Chase. 

For example, say you need $5,000 to cover your baseline monthly expenses. A fully funded emergency account will have anywhere between $15,000 to $30,000 in available funds. But this figure will depend on your individual needs and situation. 

Income and Job Stability

Your income is a factor to consider when setting your emergency fund goal. People with irregular cash flow, like self-employed or commission-based earners, may benefit from a larger financial cushion. But if you earn a predictable salary, you may be comfortable with a smaller emergency fund. 

Another factor to consider when determining your emergency fund size is job security. It might be wise to boost your emergency fund if you’re a freelance worker or have a job in an industry with high employment turnover, especially during an economic downturn. 

Dependency Status

Another important consideration is your dependency status. A smaller emergency fund may be enough if you don’t have dependents or have a dual-income household. If you can rely on family for financial support, you likely don’t need a sizable emergency fund. In contrast, single-income earners with dependents, like children or elderly parents, may need a larger emergency fund. 

Insurance Coverages

Like an emergency fund, insurance is a financial tool to help you manage your risk. You may not have to build a significant financial buffer if you’re adequately insured. For example, you’ll likely rely on your health insurance to pay for a trip to the emergency room over your emergency fund. 

It’s worth noting that insurance has its limitations and won’t cover everything. Additionally, your policy may only pay for a portion of the bill. Be sure to factor in any deductibles, co-payments and other out-of-pocket expenses you may be responsible for.

Best Places to Keep an Emergency Fund

The ideal emergency fund is in an easily accessible, FDIC-insured savings account. It might also provide a high annual percentage yield (APY), which can help you save more money. You probably don’t want to keep your emergency fund in an investment account. While investing yields higher returns in the long term, the last thing you want is for your savings to disappear to short-term losses, especially in a bearish market. 

High-Yield Savings Accounts

A high-yield savings account (HYSA) generates a higher yield than your standard checking or savings account, producing returns near 5% APY or higher. Compare this to a savings account at a traditional bank, which generates an average of 0.46% per year, according to the FDIC. 

It also lets you quickly and easily transfer funds to an external bank account. But traditional banks don’t typically offer the best rates. So you may have to open one with an online bank. 

Money Market Accounts

Similar to a HYSA, a money market account can generate high returns. This account also acts as a checking account, allowing for features like check-writing and debit card transactions. Ease of access may be convenient when you need to withdraw your funds immediately. But some money markets usually require a large, upfront investment in fees and a minimum balance.

Certificates of Deposit

Certificates of deposit (CDs) grow your savings at a fixed rate until the agreed-upon maturity date. While CD rates can be high, they’re not as accessible as HYSAs. If you withdraw your money before your account is set to expire, you may face a penalty fee.

One way to get around this is to ladder your CDs. Laddering your CDs involves purchasing multiple CDs set to expire on different dates. As a result, you can access a portion of your savings when you need it at various times without having to pay a withdrawal fee. For example, say you build a $25,000 emergency fund and want to put $10,000 of your savings into a CD ladder. You could open five CDs with $2,000 each and set them in 12 months, 24 months, 36 months, 48 months and 60 months.

No-penalty CDs are also an option. These savings accounts let you grow your money at a fixed rate without charging an early withdrawal fee. That said, fee-free CDs yield lower interest rates and have limited term options. It’s also not as widely offered. 

Traditional Banks

If you prefer banking in one place, you may want to keep your emergency savings at your traditional bank. Unfortunately, brick-and-mortar banks tend to have low interest rates, high fees and monthly withdrawal limits. Research banks that offer optimal rates and low costs if you intend to work with a physical bank. 

How to Build an Emergency Fund

After figuring out how much and where you want to save, it’s time to start contributing to your emergency fund. Even if you aren’t an avid saver, the following steps can help you build that muscle. 

Free Up Your Budget 

A budget can help you save consistently and show you the best way to allocate your funds. As you create your budget, make your emergency fund a priority. That may mean cutting back on non-essential expenses to allow for room to save. If your cost of living is still high, find opportunities to save on non-discretionary expenses by comparing costs or downsizing. 

You should prioritize paying off high-interest debt first. “If you have credit card debt, that is an emergency to be paid down now, then build up your fund,” says Jay Zigmont, CFP® and Founder of Childfree Wealth. 

Using a budgeting app or practicing techniques like the snowball or avalanche method can help effectively eliminate your outstanding debt. If your monthly payments are high, strategies like debt consolidation and negotiating your bills can make your payments more manageable. Other ways to save more include selling unused items, working a part-time job or doing a side gig. 

Make Consistent Contributions

Making consistent contributions ensures your emergency fund doesn’t fall by the wayside. If you forget to make payments or prefer to set it and forget it, consider setting up automatic transfers from your checking to your savings account. Be sure your checking account has sufficient funds to transfer to avoid overdraft fees. 

Building an emergency fund can prove challenging if you’re paycheck to paycheck or struggle to spend within budget. In that case, contributing as little as $5 to $10 each month is still worthwhile. “Once you get in the habit of setting that amount aside, aim for two months of rent/mortgage, then three months of essential expenses, and so on,” says Gromada. 

Save Windfall Income 

Windfall income, such as a bonus, gift money or a larger tax return, can be a pleasant surprise. But don’t be too quick to spend this money. Consider chucking all or a portion of that windfall income to fast-track your emergency savings goals. The sooner you build your fund, the sooner you’ll have the flexibility to allocate money towards more meaningful goals. 

Replenish Your Funds

Life’s unexpected blunders don’t stop at one. If you use a portion or all of your emergency fund, you’ll need to replenish it. Unfortunately, this means tightening up your budget or finding opportunities to earn. 

As your financial needs change, your emergency fund will also need to adapt. “It’s a good idea to revisit your plan from time to time or when you experience a life event that impacts your income, like marriage, starting or adding to your family or buying a home,” says Gromada.

While you shouldn’t hesitate to tap into your savings when necessary, using it for true emergencies is the best way to minimize the need to replenish it. Avoid using your emergency fund to cover a non-essential or routine expense.