You never know when an emergency will strike and leave you with unexpected bills to pay. Car repairs, medical emergencies and the sudden loss of a job can all be sources of surprise costs, but an emergency fund — or a "rainy day fund" — can mitigate the stress of these crises.
An emergency fund is your best tool for dealing with financial dilemmas, but how much money do you need to save in one? If you want to be prepared, learn how to create your own emergency fund and protect your financial future.
What is an emergency fund?
An emergency fund is a set amount of money that you put aside to cover unexpected or sudden expenses, like medical bills, job loss, car accidents and home repairs. Emergency funds are a staple of good financial planning.
Any money you set aside for emergencies can be considered an emergency fund, whether that’s $500 or $20,000. A good rule of thumb, though, is to have three to six months’ worth of living expenses saved in a special account. Unlike retirement funds where you may incur taxes for early withdrawals or investment funds where the money is not liquid, emergency funds are available to you at any moment.
Why do you need an emergency fund?
According to the Federal Reserve, only 54% of American adults have socked away enough savings to cover three months of expenses in a rainy day fund. But why does it matter if you have an emergency fund? Is it even really necessary?
Anyone can tell you that an emergency can strike at any time, leaving you with expenses and bills you weren’t expecting. Maintaining an emergency fund is a way to protect yourself financially against these unpleasant surprises.
Say, for example, you lose your job unexpectedly during a recession. You’re suddenly without income but still have to pay all your usual living expenses. If you have an emergency fund, you may be able to use that money to cover your necessary expenses while you’re between jobs. Without this safeguard, you might find yourself taking out high-interest loans or making other risky decisions in order to pay your bills.
Put simply, your emergency fund acts as a safety net so that you’re still financially secure even if the worst happens.
How to start an emergency fund
Starting your own emergency fund can feel overwhelming at first. But you can start your new rainy day fund by taking a few simple steps, like making a budget and changing your saving habits.
Make a budget
To be able to set money aside in an emergency fund, you must have a good handle on your financial situation. That’s where a budget can come in handy.
To make a budget, calculate your net monthly income, including any money you make from part-time jobs or side hustles. Your net income is your total take-home pay, or your earnings minus any deductions and taxes you owe.
Next, estimate how much you spend monthly on fixed and variable expenses. Your fixed expenses are the same every month and generally include car payments, mortgage or rent payments, and debt payments. Variable expenses change from month to month and can include things like groceries and utilities. Check credit card and bank statements to help you come up with these totals.
Then subtract your estimated expenses from your estimated monthly income. The number you get — if positive — is the amount you can currently save each month without changing your spending habits.
Set a monthly savings goal
Your next step is to decide how much you want to save monthly in order to contribute to your new emergency fund. Consult your budget and look at the amount you’re currently saving. If you don’t want to change your spending habits or income, simply set a monthly savings goal equal to or less than this figure. How much you should save every month is entirely up to you and depends on your personal financial goals.
In addition to your monthly savings goal, you may want to also set a target amount for your emergency fund. A simple way to set this goal is to multiply your monthly living expenses by three. The result will be the amount of money you need in your emergency fund to cover three months of expenses.
Modify how much you save
Your current spending habits may not allow you to contribute as much as you’d like to your emergency fund. In that case, you may have to adjust your spending, income or both to save money.
Anywhere you can cut spending or increase the amount of money you’re bringing in can be an opportunity to contribute more to your emergency fund. Make big or small adjustments as needed to meet your monthly savings goals.
Save your tax refund
Beyond making regular contributions, a great way to beef up your emergency fund is to save any extra cash you receive. Your tax refund, for example, could make a great addition to your emergency fund.
Regularly check your progress
Your emergency fund likely won’t require much maintenance, but don’t just set it up and never look at the account again. Regularly check your progress by looking at your balance and seeing how close you are to your goal. It can be motivating to see your emergency fund gradually grow over time. Use that motivation to stay on track and keep making contributions until you reach your target amount.
Where should you keep your emergency fund?
Once you’ve started your emergency fund, you need to decide where to keep that money. Hiding it under the mattress isn’t going to cut it, so consider other options, like putting your emergency fund in a savings account or money market account.
Many people opt to keep their emergency funds in traditional savings accounts. These accounts pay modest interest on your money but typically have some restrictions. For instance, your bank may limit you to six or fewer monthly withdrawals from your savings account. While that shouldn’t be a problem because you (hopefully) won’t need access to your emergency fund more than six times monthly, it’s still something to be aware of.
When comparing different savings accounts, pay close attention to the annual percentage yield (APY), the minimum deposit requirement and any maintenance fees. The best savings accounts offer strong interest rates and impose low fees.
Money market account
A money market account is like a cross between a savings and checking account. Similar to a savings account, money market accounts pay interest on your balance. They may also be subject to restrictions on how many times you can withdraw or transfer money from your account each month.
Like a checking account, though, these accounts often include check-writing abilities and a debit card. Keep in mind that you may need to make a larger minimum deposit to open or maintain a money market account than you would with a traditional or high-yield savings account.
High-yield savings account
Of the many types of savings accounts out there, a high-yield savings account is likely the most ideal for holding your emergency fund. These accounts generally operate like traditional savings accounts with a higher interest rate. Your emergency fund is still accessible in a high-yield savings account, and you’ll earn more interest on your account balance.
Many of the best high-yield savings accounts are available through online banks. Because they don’t have to shoulder the cost of operating in-person branches, these banks can offer higher interest rates than brick-and-mortar banks.
The drawback of putting your emergency fund in a high-yield savings account at an online bank is that you often can’t go in person to withdraw your money. If being able to do your banking in person is important, you may be able to find high-yield savings accounts at physical banks, too.
Why should your savings account and emergency fund be separate?
Some people wonder why they need a separate emergency fund when they already have a savings account. While you can add your emergency fund money to an existing savings account, that’s likely not the best way to manage your finances.
Keeping your emergency fund in a separate account from your other savings will help prevent you from dipping into money you earmarked for emergencies. Either accidentally or through a lapse in judgment, you may use your emergency fund if you keep that money in your savings account.
What is an emergency fund FAQs
What are three questions to ask yourself before you spend your emergency fund?
You need to be careful about spending money from your emergency fund. Don't tap the account unless you absolutely need to because something unexpected happened.
If you're thinking about dipping into your emergency fund, try asking yourself: Is this an unanticipated or surprise expense? Do you absolutely need to pay this bill now? Do you have no other means to cover this expense?
Unless the answer to all three of these questions is "yes," you probably shouldn't use your emergency fund.
How much should I have in an emergency fund?
Experts generally recommend having three to six months' worth of living expenses in your emergency fund. If you're not sure what your current living expenses are, estimate the amount you spend on each of these categories every month: housing, utilities, transportation, food and groceries, debt payments, health care, personal expenses, child care and pet food.
However, three to six months of expenses may not be enough for some people. Consider increasing your emergency fund target if you're retired (especially if most of your money is tied up in non-liquid assets), you have inconsistent income, you're planning on leaving your job before securing new employment, or you work in a high-risk industry where your job is not secure.
These situations make it more likely that you'll have to rely on your emergency account for your household expenses. A larger emergency fund can provide a more reliable safety net if your income slows down or goes away.
When should you use your emergency fund?
There are no rules about when you can or cannot use your emergency fund. Still, try not to use your emergency fund for unnecessary purchases because it may leave you without money for an emergency later on.
Scenarios in which you might use your emergency fund include sudden loss of income, unexpected medical expenses, car accidents and repairs, and surprise home repairs.
How often should you contribute to your emergency fund?
You can contribute to your emergency fund as often as you want. Regular contributions to the fund will help you hit your target amount faster, but if you can only afford to occasionally add money, that's OK, too — it's better than not growing your fund at all.
It may be helpful to think of your emergency fund contributions as a bill you must pay regularly (e.g., monthly, quarterly). When the time comes, make your contribution so you can build up your emergency fund. You'll hit your target amount before you know it.
Once you hit your goal amount in your emergency fund, you don't need to keep making regular contributions (unless your financial situation changes or inflation shifts the economy). Make sure to start your contributions back up again if you draw on your emergency fund, though, to replenish it.