How to Create an Emergency Fund

Wouldn’t it be great if life always worked out as planned? The reality is that life is full of unexpected events, some of which can put you in financial trouble if you don’t have the extra money on hand to handle them. According to a report by the U.S. Federal Reserve, 37% of adults revealed they could not cover an unexpected expense of $400 in cash, with most reporting they would use credit cards or borrow from friends to cover the expense.¹

Without an emergency fund to fall back on, unplanned expenses like house repairs and car trouble — or worse, sudden unemployment — could leave you unable to pay bills and make you more likely to take on additional debt. That’s why building an emergency fund is not only important, it can be a lifesaver.

The thought of putting money aside for emergencies may seem like a tough task, especially during economic uncertainty. But any amount you save could make a big difference when you really need it — and could reduce the stress of a financial hardship.

Here are a few tips to help you learn how much money you should have in your emergency fund, where you should build an emergency fund, and how to use tools like a budget calculator to reach your savings goal:

1. Calculate your expenses to determine how much money you should have in your emergency fund

Ideally, you should have six months of living expenses saved up.2 If you’re unsure how much your living expenses are, add up every bill you regularly incur each month such as housing, utilities, health care, gas, insurance, child care and groceries.

How much money should you have in an emergency fund?
Once you know your monthly expense total, multiply it by six. For instance, if your expenses add up to $4,000 a month on average, you should have around $24,000 stashed away in your emergency fund. If this savings goal seems a bit high, consider creating a budget to help manage and monitor your expenses. This free online budget calculator can help you see where your money goes every month, which expenses can be reduced or eliminated, and how to save more money.

2. Decide where to build your emergency fund

While emergency funds should be reserved for true emergencies, you still want your money to be within reach when you need it. The key is to make sure your money is safe, can earn interest and is accessible — but not so accessible that you end up spending it prematurely.

Choosing the best place for you to stash away emergency cash varies from person to person. One option may offer greater returns but with higher possible fees, while another offers only modest returns but gives you a greater sense of security. Here are a few suggestions for where to keep your emergency fund:

• Traditional bank or credit union account — If you already have a savings or checking account at a bank or credit union, it’s easy to create an additional account at the same institution and designate it as your emergency fund. This makes it easy to move money from one account to another.

• High-Yield Savings Account — With a high-yield bank account, your money earns more interest over time than it would in a traditional bank savings account. But keep in mind that since these types of accounts are commonly found at online banks, it may be harder to access your money at a moment’s notice.

• Money Market Account — While this type of account also earns a higher annual percentage yield (APY) than a traditional savings account, it does typically require a larger minimum deposit to open an account. Most money market accounts require a minimum balance of at least $2,500, and if your balance drops below that amount, you may be subject to fees.

• Certificate of Deposit (CD) — A CD is like a savings account, but for a fixed length of time — anywhere from three months to 10 years.3 But unlike a traditional or high-yield savings account, withdrawing your money from a CD before the term expires results in an early withdrawal penalty.

• Roth Individual Retirement Account (IRA) — A Roth IRA could be worth considering if you’re hoping to earn much higher returns than you would with other savings accounts. But as with most investment vehicles, your Roth IRA could lose value. And if you need to access your money quickly, the penalties associated with withdrawing could be costly.

Be sure to examine all options carefully before making your choice. After all, this is money that you’re working hard to set aside, and you want to save it in a place that offers growth, security and accessibility.

3. Treat your emergency fund like another bill

We’ve all heard the expression, “Pay yourself first.” One of the most recommended ways to do so is to set up automatic transfers from your checking account. Or better yet, find out if your employer offers direct deposit into two accounts, sending a few dollars of your paycheck to your emergency fund account automatically. You’d be surprised at how fast even the smallest contributions add up.

If you’d rather not set up automatic deductions, make sure you treat your emergency fund as you would any other expense — it’s another bill that you have to pay monthly.

Is it better to pay off debt or save an emergency fund?
As you adjust your budget to account for your emergency savings, a common question may be whether that extra money should go first toward paying off debt rather than into your emergency fund. If you’re juggling multiple cards and other high-interest, revolving debt, paying off those accounts should be a priority, and taking control of your finances may mean looking into other financial options, such as debt consolidation, to help pay off several bills, lower the interest rate and reduce your debts faster, allowing you to do both: pay off debt and save into an emergency fund.

4. Stick to it and adjust as needed

With savings, any progress is good progress. So, no matter how long it takes you to fund your emergency savings, just know that you’re headed in the right direction and will get there as long as you stay committed to your goal. And if you encounter a few bumps along the way, adjust as needed and focus on saving what you can, when you can, until you rebound.

5. Look for additional ways to make more — and save more.

The more money you make, the more you can set aside for your emergency fund. If your current employment isn’t providing you with the income necessary to save as much as you’d like, maybe it’s time to explore new ways of generating income.

Use your experience, skills and interests to make extra money on the side as you work toward building your emergency fund. It doesn’t have to be a permanent side hustle, just enough to get you closer to your savings goal.

And once you’ve saved up your emergency fund, commit to using it as a last resort for emergencies only — meaning you and other family members are clear on what defines a “true emergency.” That way, when you really need it, you’ll have peace of mind knowing you have the cash to handle it, pay your bills and keep moving forward.

1. https://www.federalreserve.gov/publications/files/2019-report-economic-well-being-us-households-202005.pdf
2. https://www.mycreditunion.gov/life-events/planning-unexpected
3. https://www.investopedia.com/terms/m/moneymarketaccount.asp