How To Start an Emergency Fund

An emergency fund is a dedicated amount of cash set aside for unexpected expenses, such as unplanned repairs, medical emergencies or loss of income. Developing and maintaining an emergency fund is a core component of financial wellness, as it helps safeguard your financial security against future events.

Emergency funds can be used for a variety of unexpected financial circumstances. These might include your car needing costly repairs, or being in an accident resulting in medical bills or suddenly losing your job. An emergency fund can help offset the costs of the unplanned expenses or loss of income.

If you’re not putting savings into an emergency fund, unplanned expenses can have a drastic impact on your personal finance. Research shows that people who struggle to recover from financial setbacks have a harder time saving money to protect themselves for future emergencies.

With money to cover potential expenses like hospital bills or home repairs, you can avoid going into debt, which could cost you even more with interest. An emergency fund also prevents you from having to dip into other forms of savings, such as a retirement account, to cover costs.

How much you need in an emergency fund will vary depending on your individual financial situation. Conventional wisdom suggests that households should save three to six months of expenses to build a robust emergency fund.

It’s worth noting that while saving half a year’s worth of expenses is a good goal to have, saving that much money can take years or be completely unattainable for some households. But that doesn’t mean lower-income families shouldn’t try to have emergency savings.

A study from the Financial Industry Regulatory Authority found that even savings of $100 to $250 increased the likelihood of financial stability in low-income households. Households who could maintain a savings balance of at least $100 reported feeling more financially satisfied than those who could not.

Now that we’ve discussed the importance of an emergency fund, let’s review how you can create and maintain your own. Here are six simple steps to building a robust emergency fund.

Your emergency fund should be kept in an account that’s easy for you to access if you need the money fast. That means that bank products like bonds or certificates of deposit are better used for long-term savings goals rather than an emergency fund.

You can put your emergency fund in a traditional savings account that’s linked to your checking account, so you can easily move money from your checking account into savings. If your bank offers a high-yield savings account, that’s likely the best option. These accounts earn much higher interest rates, so your money will continue to grow even if you can’t contribute to it for a time.

Deciding when to spend your emergency savings depends on your definition of an emergency. Typically, experts recommend leaning on the conservative side when it comes to dipping into your emergency fund.

If you can afford to budget for variable but not urgent expenses, such as car repairs or home maintenance, then those circumstances probably aren’t worth cashing out your emergency fund savings. You want to save that money for true emergencies, such as losing a job or unexpected medical issues.

While an emergency fund prepares you for the worst, many financial professionals also recommend putting savings in a separate “opportunity fund” for a sudden business or investment opportunity or happy event.

Like an emergency fund, an opportunity fund should be made up of cash or other liquid assets — allowing you to quickly take advantage of the opportunity without having to strain your budget or dip into your emergency fund.