Emergency Fund: What is It and How to Get Started

Discover the importance of having an emergency fund and learn how to get started with our expert guide. Secure your financial future today.

Emergency Fund: What it is and why you need one

When you come home from work, the last thing you want to find is a puddle on the kitchen floor next to a smoking refrigerator. After you throw away the spoiled food and make alternate dinner plans, you have to go shopping. 

Appliances aren’t cheap. But you don’t have to cry over your figuratively spilled milk if you have an emergency fund to cover situations like these. Discover more about emergency funds, how they can help, and how you can build one in the article below.

Emergency fund definition

An emergency fund, by definition, is a stash of cash that you can easily access when you need to cover a financial surprise. You may call it a rainy-day fund, a safety net, or a nest egg. The point is that you have money to use when you need it most. Instead of stressing out about how you’ll come up with the money — or which bill to skip — you can solve the problem immediately.

Why do I need an emergency fund?

It’s easy to wonder why you even need an emergency fund. After all, if you’re setting aside money in a savings account, isn’t that enough? 

Typically, an emergency fund is intended to offset the cost of unexpected expenses. It’s not meant to be used to save toward a short- or long-term savings goal, such as a new car, a home, or retirement.  

Having money available to cover emergencies when they strike is comforting, but how do you know you’re dealing with a true emergency? Just ask yourself three questions

  • Is the situation unexpected? 
  • Is it urgent? 
  • Is it necessary? 

The following situations may qualify as emergencies: 

  • Car repairs 
  • Home repairs 
  • Job loss 
  • Unexpected medical expenses 
  • Unplanned travel expenses 

Consider these examples: 

Changing the oil in your car is necessary, but it’s not urgent or unexpected. That’s an expense to include in your regular budget. 

Repairing a cracked radiator, though, is necessary and urgent. Your emergency fund is there to help you pay for this type of unexpected expense.  

How to Build an Emergency Fund 

Setting an emergency fund aside can be a new concept for some people. When paychecks come in weekly or biweekly, it’s easy to lose track of the discretionary income leftover after the bills are paid. Follow these steps to build an emergency fund, so you and your family can rest easy. 

1. Determine how much you want to save 

It isn’t easy to save when you don’t have a target in mind, so start by setting a savings goal. Financial experts typically recommend stashing away three to six months’ worth of expenses in your emergency fund, but the exact amount you need in the account varies depending on your financial situation. Some budgeting and savings professionals, like Suze Orman, recommend saving enough money to cover 12 months of expenses for maximum security. 

If you’re still paying off credit cards or student loan debt, saving that much money may seem nearly impossible. But that doesn’t mean you should skip the emergency fund. Yours may look a little different at first. 

Aim for a starter fund with $1000.  As you pay down your debts, you can contribute more to your emergency fund until it’s fully funded. 

2. Choose where to put your emergency fund 

Choosing the location of your emergency fund is as simple as selecting a bank and opening a savings account. In fact, this is an excellent option for most people. You can take out money at an ATM or transfer it to your checking account as needed. You can also have money automatically added to your emergency fund account when you receive a paycheck. 

Ideally, you should choose a different bank than the one you use for your regular checking. The less convenient it is to withdraw money, the less likely you are to borrow for something unnecessary, like a more impressive Christmas gift or new sneakers. 

It also helps to find a savings account that pays high interest. You won’t fund your retirement with the interest you make, but you may as well earn what you can on the money while it’s not in use. 

3. Create a budget

After you set up your emergency fund account, it’s time to start making deposits. Setting a monthly budget can help by showing how much money you have coming in and where it’s going each month. 

If planning a budget seems overwhelming, there are several popular frameworks – like the 50/30/20 rule – you can use to help you start keeping track of your income and expenses. Then, look for ways to cut back on your spending so you can contribute more to your emergency fund. 

If you can’t cut back on your current expenses, consider ways to create more income. Consider taking a second job or starting a side hustle to earn extra money to set aside in your emergency fund. 

Another option is to sell items you own, but no longer need. A few dollars here and there add up, and you’ll start to see the balance in the account increase. 

4. Consistently move money into your emergency fund account

Once you designate your emergency fund, it’s important to get in the habit of consistently contributing to the account. Between regular contributions and account interest your emergency fund should grow nicely until you need it.  

If you struggle to contribute to the account consistently, most banks allow you to easily set up automatic contributions. Some banks may also allow your to round up purchases to the next dollar and deposit that money into a separate savings bucket.  

Regardless of the method you choose, the important thing is to contribute money to grow your emergency fund consistently.  

5. Monitor your progress and decide if you need to make adjustments

A successful emergency fund doesn’t end after you set up your account and savings process. You’ll want to track your progress as you go and determine if you need to make any adjustments to your savings plan along the way. 

Use the notifications in your online banking app to keep track of your emergency fund. Watching your balance grow can be a great motivator to keep saving and making responsible money choices. After saving for a while, revisit your budget and make any necessary adjustments. 

Save for a rainy day 

When life surprises you, having an emergency fund available does more than provide the money you need at the moment. It also gives you peace of mind and helps you avoid unnecessary stress. You’ll have one less thing to worry about as you swiftly handle the inconvenience.