CouponFollow (go to the homepage)

The Ultimate Guide To Creating An Emergency Fund

14 min read

An emergency fund is something that everyone should strive to have in place, as it will be crucial to your financial well-being should a large unexpected cost or financial emergency suddenly arise. In this guide, you’ll learn why you should have an emergency fund, how much an emergency fund should be, where to keep an emergency fund, and the best methods for building an emergency fund to the recommended levels.

What Is an Emergency Fund?

An emergency fund is money that has been set aside specifically for large unforeseen expenses or financial emergencies. These unplanned expenditures do not include routine monthly expenses.

Unexpected Expenses and Financial Emergencies You Could Face

  • Job Loss: This is one of the biggest reasons to have an emergency fund in place, so that you can continue to pay for things even without a paycheck coming in.
  • Major Medical and/or Dental Bills: Unexpected medical or dental bills can arise at any time and put you in debt, even with insurance.
  • Emergency Veterinary Bills: The cost of pet ownership is fairly low, until a medical emergency occurs and your pet needs thousands of dollars worth of care.
  • Car Repairs: Car repairs aren’t cheap, and an unexpected accident or worn-out part can set you back hundreds or even thousands.
  • Home Repairs: One thing homeowners can agree on is that owning a home comes with a lot of repairs that will need to be done over time.
  • Family/Friend’s Emergency: If a family member or friend needs help with their own sudden financial emergency, it’s nice to have the ability to help out.
  • Legal Issues: If you’re suddenly facing a legal issue, hiring an attorney can be costly.
  • Identity Theft: You may lose access to your credit lines while dealing with identity theft.
  • Owing the IRS: If you miscalculate your tax withholdings, you could owe the IRS more in taxes than expected.
  • Last-Minute Travel: You may need to purchase a last-minute plane ticket due to a death or illness in the family, which can be costly.
  • Funeral Costs: Funerals can be expensive and often need to be paid for before the family receives the loved one’s life insurance benefits.

Why Is an Emergency Fund Needed?

An emergency fund is important to have in place as a buffer for your finances if you are faced with a large unforeseen expense or emergency. Without an emergency fund in place, you might have to rely on borrowing money through credit cards or loans, both of which can have high interest rates that will cost you even more in the long run.

Using credit cards or loans to pay for an emergency repair or expense also puts you in debt, which can be harder to pay off in the future without having those emergency funds to put toward it. Debt happens when you spend more money than you bring in, and it can snowball into more and more debt until lifestyle changes and sacrifices have to be made.

How Much Should Be Saved in an Emergency Fund?

The rule of thumb is to have enough in your emergency savings fund to cover three to six months worth of expenses. Six months worth of expenses should be the goal for those in a single-earner household, while a double-earner household should have at least three months worth of emergency funds. If you were to lose your job, this emergency fund amount is meant to keep your household afloat while you seek employment.

The amount of emergency funds needed to cover this time period will depend on the monthly expenses of your household. Necessary expenses such as food, rent or mortgage payments, car payments, loans, and utilities should be factored into the total amount that needs to be saved, which can be different for every household. Here are a few different emergency fund calculators that can be used to find out how much you should be saving every month to build up your emergency fund:

While there’s no harm in having an emergency fund that covers far more than the recommended three to six months, having too much in your emergency fund can have disadvantages. The biggest drawback is that emergency funds are often kept in a savings account with a low interest rate, which could cause you to actually lose money over time due to inflation. You can earn more money by investing those excess emergency funds into an employer-matched 401(k) account or into an individual retirement account (IRA) instead.

Interested in setting up an IRA with your excess emergency savings fund? NerdWallet has a list of the 14 best IRA accounts to use when saving for retirement.

How to Build an Emergency Fund

  1. Find the total amount you need to save. To start building an emergency fund, first, figure out the total you will need to save for the recommended three to six months worth of expenses, which can be found using one of the emergency fund calculators above.
  2. Create monthly savings goals. Set a goal for how much you want to save each month, and start putting a set amount from each paycheck toward your emergency fund. This process can be made easier by automatically transferring a portion of your paycheck to your savings account through direct deposit or small automatic transfers between your accounts.
  3. Save change or small bills. Put any change or small bills you receive after breaking a bigger bill into a jar to add to your savings account once it’s full. Some have also found success with money-saving challenges, like the $5 bill hack, with which you can save hundreds of dollars by the end of the year by putting away every $5 bill over the course of the year. And if you routinely use coupons, try putting the money you save directly into your savings account.
  4. Use money-saving apps. These apps can automate the process of saving money in a way that is barely noticeable. Many of them save through “round-ups,” where the purchase price is rounded up to the nearest whole dollar and the extra change is automatically added to your savings. Here are some top money-saving apps:
    • Best investment options: Acorns
    • Best banking alternative: Simple
    • Best for goal-setting: Qapital
    • Best for simplicity: Digit
  5. Pay yourself. If you’re eliminating services from your budget, such as lawn care, cable television, a housekeeper, or a hair stylist, put the money you’re saving directly into your savings account.
  6. Put your tax refund into savings. Putting your tax refund immediately into savings instead of treating yourself with it will give a big boost to your savings goals. This applies to any influx of money you may receive over the year, such as cash gifts or lottery winnings.
  7. Pay attention to your emergency fund levels. Don’t forget to check in on your emergency fund every couple of months to make sure you’re on track to reach your savings goals and make any adjustments needed after a major purchase or life event that caused you to dip into your savings.

Knowing basic financial facts and the best practices for saving is a crucial step toward understanding how to plan better for emergencies. The financial literacy resources below for kids, and the whole family, are great tools to help put an emergency savings plan into action.

Resources to Help Kids Learn How to Save Money

As Dave Ramsey once said, "The first step to teaching your kids how to handle money is being a good example." It’s never too early for children to start learning the value of money and why saving it is important. Teaching them money management skills like how to budget, save, and even invest at a young age will help them to be more financially independent when they’re older.

Resources to Help Anyone Grow a Rainy Day Fund

Everyone, not just kids, should brush up on their money-saving skills. It’s never too late to start saving for your financial future! The following links will give you the tools you need to start implementing the best methods for saving money and different ways you can start to grow a rainy day fund to be used for any financial emergencies that may arise in the future.

Where to Keep an Emergency Fund

There are a variety of options to choose from when you’re deciding where to keep your emergency fund. You’ll want your emergency fund to be easily accessible should an emergency situation arise, but it shouldn’t be so easily accessible that you’re tempted to spend it on other things. It’s a good idea to keep your emergency fund separate from your other bank accounts to avoid spending it by accident.

  • Cash: One option is to keep your emergency fund in cash. This is the most accessible option, but it’s also the most tempting to spend on non-emergencies. Another thing to consider is that cash is not protected and could be stolen, destroyed in a fire or other natural disaster, or simply lost somewhere in the house.
  • Traditional Bank Account: A traditional bank account is another simple option for your emergency fund. You’ll be able to access the funds you need quickly, but the interest rates are generally low, so you won’t earn as much over time. If you’re going with this option, it may be in your best interest to open an account with a different bank than the one you primarily use, so you’re not tempted to withdraw your emergency funds when they’re not truly needed.
  • High-Yield Savings Account: A high-yield savings account is a popular option for an emergency fund. The best savings accounts have high annual percentage yields (APYs), which will help you to earn more while you continue to save. Here are some of the best high-yield savings accounts:
  • Money Market Account: Another option is a money market account, which is similar to a high-yield savings account in that it earns a higher APY than a traditional bank account. In some cases, a money market account can be a more convenient option if it comes with a debit card and the ability to write checks, but a larger minimum deposit is usually required to open a money market savings account, and you’ll often need to maintain a higher balance to earn the high APY. Some of the best money market savings accounts include:
  • Certificates of Deposit. Another place to keep an emergency fund is in certificates of deposit (CDs), although they differ from the other options because your money isn’t as easily accessible. CDs generally earn a higher interest rate than other bank accounts but require that you keep your money in the account for a specific period of time in order to receive a guaranteed rate of return. This time period can be anywhere from a few months to a few years, which could be an issue when you need to access your money for a sudden financial emergency.

When to Use an Emergency Fund

It’s best to save your emergency fund for when you really need it: Fixing the broken-down car you use to get to work is an emergency, for example, but not having the money to soup up the exhaust system isn’t. Even if a sudden expense isn’t an emergency but still falls outside of your usual monthly expenses, you can use your emergency funds to pay it off, but try to avoid making it a habit. Definitely don’t spend any of your emergency funds on things that are wants, not needs.

Go Forth and Save!

Now that you’re armed with the resources you will need to start an emergency fund, your financial future should be looking much brighter! Take time to sit down with your family and figure out just how much will need to be saved each month to start building an emergency fund, then start planning different ways that everyone in the family can contribute. Letting kids help out with the family emergency fund, even if it’s just a small amount, is a great way to teach them about money management and the small sacrifices that need to be made from time to time for a more secure financial future.

Editors Picks