What Is an Emergency Fund and When Should You Use It?
Written by
Jacob Wade
Edited by
Elizabeth Constantineau
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Life happens. And when it does, it can be expensive. Whether it’s a blown car transmission, a leaky roof or job loss, having money set aside for life’s emergencies is always a good idea. A key part of an emergency fund is deciding how much to save and how to utilize it.
What Is an Emergency Fund?
An emergency fund is money set aside in a bank account for unplanned expenses, such as:
- Major home repairs
- Unplanned medical bills
- Job loss
The money is earmarked for unexpected events and expenses that could wipe out your budget in a hurry and potentially cause you to go into debt. Emergency funds need to be readily available to help pay for last-minute expenses.
Why Do You Need an Emergency Fund?
An emergency fund is designed to create a buffer between you and life. The funds are set aside to help you pay for high-cost repairs and other financial emergencies that might otherwise have you reaching for a credit card.
An emergency fund can also help lower your financial stress. If you’re living paycheck-to-paycheck, even a small financial emergency can force you to use a credit card or short-term loan to cover the expense. With an emergency fund in place, you don’t have to worry about most financial emergencies, and when an emergency does happen, the financial part is already taken care of.
Where Should You Store Your Emergency Fund?
Your emergency fund should be stored in a liquid bank account — allowing quick access to funds within 24 hours or less. This includes accounts like:
- High-yield savings: A high-yield savings account offers the same protections as a regular savings account but typically pays a much higher interest rate on your deposits. Since your emergency fund cash will be sitting idle most of the time, a high-yield savings account can at least provide some return. Plus, the funds are FDIC-insured and can usually be accessed through an ATM or payment apps like Zelle.
- Money market: A money market account is another high-yield bank account that offers FDIC insurance and high interest rates but may also offer more flexibility than a regular savings account. Many money market accounts offer check-writing privileges and ATM access, making it even easier to access your funds. But there may be a monthly transaction limit so it’s a good idea to check with your bank before depositing funds.
- Regular savings: If you don’t have access to a high-yield account, putting your emergency fund in a regular savings account works just fine. You won’t earn the most interest but your funds are still FDIC-insured and easily accessible.
You want to avoid investing your emergency fund, as you risk losing your capital and the funds aren’t liquid. Timed deposit accounts like a certificate of deposit should also be avoided since they can penalize you for withdrawing your funds early.
How Much Should You Have in Your Emergency Fund?
The amount of money you put into an emergency fund depends on your stage of life, work circumstances and other financial factors. There are a few rules of thumb that can be followed to determine how much to save in an emergency fund:
One-Month Rule
The one-month rule is for building a beginner emergency fund. The rule states that you should save at least one month of expenses before tackling other financial goals. If you have $5,000 in monthly expenses, you should set aside $5,000 in a savings account. This is ideal for those just starting out and individuals who don’t have a lot of large obligations like a family or home mortgage.
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Three-Month Rule
The three-month rule states that you should have three months of expenses saved in an emergency fund account. This rule is ideal for individuals who have started their career and have taken on a car loan or home mortgage. This rule applies to those in dual-income households, stable jobs and no kids.
Six-Month Rule
The six-month rule states that you should set aside six months of expenses in a savings account — so if you spend $7,000 per month, you should have $42,000 saved up. This is ideal for married couples with children, a home mortgage and a single income. It’s also a good idea to have this amount set aside if you are self-employed or have unstable employment.
‘Sleep at Night’ Rule
The “sleep at night” rule states that your emergency fund should be big enough that it helps you sleep well at night. This means having enough cash that you no longer worry about financial emergencies.
Good To Know
While having a large stash of cash available for emergencies can make you feel better about your money, it’s a good idea to also be investing. Savings accounts don’t typically keep up with inflation. Investing your money can help you beat inflation and grow your wealth toward goals like retirement.
How To Start an Emergency Fund
Saving up for emergencies should be one of your first financial priorities. Here’s how to get started with an emergency fund.
Step 1: Calculate How Much To Save
Before you start saving, you’ll want to set a goal amount for your emergency fund. This amount depends on your preferences and financial circumstances, but is usually at least one month of expenses. Set a goal so that you know when you have enough saved in your account.
Step 2: Open a High-Yield Savings Account
You’ll need an account to save your emergency fund in and a high-yield savings account offers high interest rates and easy access to your cash. There are several top high-yield savings accounts offering over 4.00% APY in 2024, making it an ideal time to make a few extra bucks on your emergency fund stash.
Step 3: Add ‘Savings’ to Your Budget
Once you have an account open, you need to make a plan to start saving money each month. You’ll want to put together a monthly budget — if you don’t already have one — and make sure to create a “savings” line item. Setting aside 10% of your monthly income can help you save quickly but the more money you can put away the better.
Step 4: Automate the Process
One quick way to trick yourself into saving more money toward your emergency fund is to automate the process. You can set up a recurring transfer from your checking account to your emergency fund savings account the day after you get paid. This makes it easy to save money without even thinking about it and gives you less time to accidentally blow extra cash that is sitting in your checking account.
Step 5: Add Extra Funds
As you continue to save toward your emergency fund, you can add any extra funds you come across. Whether it’s a tax return, a third paycheck for the month or selling items on Facebook Marketplace, stashing extra cash in your emergency fund will help you hit your savings goal much faster.
Step 6: Check in Regularly
Life changes constantly and if you have a major life event — such as getting married, having a child or buying a home — it’s a good idea to reassess your emergency fund needs. For example, you might have a three-month emergency fund set aside but then you have a child. In this case, you would want to increase the amount to six months of expenses.
Always review your financial goals on an annual basis. To stay on track, it’s a good idea to check in a few times a year.
When Should You Use Your Emergency Fund?
Once you have a stash of money set aside for emergencies, you’ll want to make sure you only use it when necessary. Setting personal guidelines for the use of your emergency fund can help you avoid the temptation of raiding your account for “non-emergency items” — like a pair of Taylor Swift tickets.
An emergency fund should be used for unforeseen financial emergencies that you cannot plan ahead for. This may include things like:
- Major car repairs: Don’t confuse this with car maintenance. You should take care of your vehicle with regular oil changes and maintenance. But if you have engine trouble or the transmission dies, you should use your emergency fund to get back on the road.
- Medical bills: Having proper health insurance can help you pay for many medical expenses but some medical bills are unavoidable. If you have an accident or medical emergency, you can use your emergency fund to help take care of the costs.
- Job loss: If you lose your job, you need to keep the lights on. Your emergency fund can help you keep up with your bills, put food on the table and keep you afloat while you find another job.
It’s important to qualify any spending from your emergency fund before you decide to access the cash. Ask yourself if it’s truly an emergency and if the expense is unavoidable.
FAQ
Here are the answers to some of the most frequently asked questions about emergency funds.- How much money is needed for an emergency fund?
- The amount you save in an emergency fund depends on what your regular monthly expenses are and how much you need to sleep at night. Most experts agree that having three to six months of expenses set aside in an emergency fund is ideal for handling most life emergencies. But it's a good idea to review your spending, your obligations and your job stability before choosing how much to save.
- Is $5,000 enough for an emergency fund?
- A $5,000 emergency fund should be the minimum amount saved for someone with $5,000 in monthly expenses. Having at least one month of expenses saved is a good idea before moving on to other financial goals. But as your career progresses and you have more family and financial obligations, saving at least three months of expenses in a liquid savings account is a good idea.
- Is $20,000 enough for an emergency fund?
- A $20,000 emergency fund is a sizable amount that could cover most financial emergencies. But while it might be enough for someone with low monthly expenses, it may be too little for a family with high monthly expenses. Experts recommend at least three months of expenses saved in an emergency fund and if you are spending $10,000 per month, you would need more than $20,000 set aside.
- Is $10,000 a good emergency fund?
- A $10,000 emergency fund can cover most major financial emergencies such as car repairs, small medical emergencies and short-term job loss. But if you have high monthly expenses or an unstable job, you'll need more than $10,000 set aside to be prepared for larger financial emergencies such as job loss. It's a good idea to save at least three to six months of expenses in an emergency fund.
