How to Start an Emergency Fund
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2024 has started on an optimistic note with inflation cooling, layoffs reducing and an improved state of economy. While we have managed to dodge the chances of a recession, nothing is certain. Irrespective of where the economy moves from here, we need to be cautious with our money. We have already seen a pandemic, major layoffs and high inflation in the past few years and it has taught us the importance of having a rainy day fund.
Regardless of their financial situation, financial security remains a lofty goal for most people. After all, you never know when an emergency will strike, that will result in a major expense. Having a “rainy day” fund for such emergencies can provide the cash you need when you need it and peace of mind knowing you’re prepared for any unexpected expenses.
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What is an emergency fund?
An emergency fund is money you can access quickly to pay an unexpected expense. This is not the same as your regular savings. Traditional savings should be for future expenses you expect:
- Purchasing a new car
- Paying college tuition
- Taking a vacation
- Planning for retirement
- Other financial goals
On the other hand, emergency savings pay for such surprise costs as major car repairs, home repairs, medical bills, or emergency travel and provide a safety net in the event of job loss. An emergency fund will give you enough money to pay these expenses without running up credit card debt or taking money away from other obligations such as utility bills, rent, and groceries.
How much should I have in an emergency fund?
The general rule for an emergency savings goal is to set aside a minimum of three to six months of living expenses. Although this number may seem daunting initially, especially if money is tight right now, don’t let it overwhelm you. Building emergency savings is a long-term goal; you can get there if you commit to creating an emergency fund.
Related: When to Use Your Emergency Fund
Steps to building an emergency fund
To successfully set up an emergency fund, you need a plan. Although it might sound easy to save money, it could fall by the wayside if you don’t have a plan of action. These steps can help put you on the right track for building an emergency fund with results you can see immediately.
Set up a budget so you know how much you can save
Before you can start saving, knowing how much you can save each month is important. Creating a budget gives you a clear picture of your monthly income and where that money is spent. To create your budget:
- Write down how much money you bring home each month.
- Add up all of your regular monthly expenses. This includes living expenses such as your mortgage or rent, utilities, groceries, and gas, as well as additional expenses such as your car payment, credit card payments, and entertainment.
- Subtract your expenses from your income. This is your discretionary income, the money you can spend as you want.
Budgeting your expenses provides a good look at where you can adjust to meet your emergency savings goals. For example, you can stay at home one night each weekend and save the money you would spend on dinner and a movie. Or you could cut back on one of your streaming services until you reach your savings goal. Small changes to your expenses could result in big savings for your rainy day fund.
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Decide how much to put in your emergency savings each month
Look at your budget to see how much money you can save immediately. This may be $20 or $200. The amount is not nearly as important as getting started. By doing so, you’ll get in the habit of putting money into your emergency fund, so it won’t seem like a hardship. You can always increase how much you save each month if you save your stated minimum amount every month.
Use savings tools to boost savings
To help increase your emergency savings, take advantage of the many savings tools now available. For instance, if you receive your paycheck by direct deposit, check with your employer to see if you can have a portion deposited directly into your emergency savings account. Similarly, check with your bank to see if it offers automatic transfers from your checking account to your savings account. If so, you can set up a recurring monthly transfer in any amount to your emergency fund.
Another option is programs and round-up apps that add to your savings. For instance, with Bank of America’s Keep the Change program, any purchase with your debit card is rounded up to the nearest dollar, with the change going into your savings account.
Savings apps also could help boost your emergency savings, but it’s important to look for one that doesn’t charge fees. For instance, in the Earnin app, you can create a Tip Jar to tip yourself whenever possible. Say you brewed coffee at home and took it to work in a reusable coffee mug instead of swinging by your favorite coffee shop. As a reward, tip yourself with a dollar or two. When ready, transfer your tip jar savings into your emergency fund. It might sound simplistic, but you’ll never miss that dollar and be surprised at how quickly your savings grow.
Stash away any extra cash
If you earn a bonus at work one month or receive your tax refund, don’t spend it all at your favorite store or restaurant. Instead, deposit a small amount for a low-key splurge, such as lunch out over the weekend, and deposit the rest in your emergency fund. Giving yourself a small treat means you won’t feel deprived or resentful while boosting your rainy day fund.
Where to keep an emergency fund
Emergency savings aim to provide quick access to cash when you need it. Therefore, it’s important to put your money not only where it’s safe but also where it’s readily available. Also, look for accounts insured by the Federal Deposit Insurance Corporation, which protects your money if the bank fails.
High-yield savings accounts
Unlike traditional savings accounts at your local bank or credit union, high-yield savings accounts offer a better interest rate, so you can earn a little extra cash on your money while sitting in the bank. According to Bankrate, the national average savings rate on a traditional savings account is 0.58% annual percentage yield APY. That translates to just $11.60 per year on a balance of $2,000.
High-yield savings accounts usually offer a much higher APY, such as Synchrony Bank’s high-yield interest account, which currently offers an APY of 4.75%. That equates to earnings of $95 per year on a balance of $2,000. Although this is still not a huge amount, it is a nice addition to your emergency fund.
When shopping for a high-yield savings account, look for one with no opening deposit or minimum balance requirements, no fees, and quick access to your money. Some accounts offer ATM or debit cards or checks for quick access, while others require a transfer from your savings account to a checking account. Those transfers may take several days, which could hinder access to your funds when you need them.
Certificates of deposit
Depending on your certificate of deposit (CD) term, you could earn a nice chunk of change on your emergency savings. For instance, according to Bankrate, the national average savings rate on one-year CDs is 1.75%.
While these fees are fixed and don’t fluctuate like those in a high-yield savings account, your money is tied up and can only be accessed without fees during specific periods during the CD term. That’s not a good choice if you need your money urgently.
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Money market accounts
Money market accounts are a hybrid between checking and high-yield savings accounts. Like a high-yield savings account, money market accounts typically earn a higher interest rate than a traditional one. That means you’ll receive a small boost to your emergency fund, which can help you reach your savings goal faster.
Like a checking account, money market accounts often come with checks, debit, and/or ATM cards, providing instant access to your cash. Unlike a checking account, withdrawals from a money market account are usually limited to six monthly withdrawals before you incur an excessive withdrawal fee. Using a money market account for your emergency fund is good because it will help prevent you from dipping into your account unless it’s truly an emergency.
Online savings accounts
Online savings accounts are similar to traditional ones at brick-and-mortar financial institutions, although many have higher interest rates on your earnings. Some interest rates may rival those for high-yield savings accounts, but not all.
When searching for an online savings account, it’s important to shop around for an account without any opening deposit or minimum balance requirements or fees. In addition, not all online savings accounts offer ATM access to your funds, so getting your money quickly could take a few days unless you also have a checking account with the same financial institution. In that case, you could initiate an online transfer from your savings to your checking account for same-day access to your money.
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Mistakes to avoid
Building an emergency fund might be long for some and short for others. Regardless of how long it takes, it’s important to stick to your plan and avoid any pitfalls derailing your savings.
Spending money when it's not an emergency
Once you accumulate money in your emergency fund, it can be tempting to use some cash for a purchase you don’t need. Always remember that your emergency savings are for unexpected expenses that pop up out of the blue. This doesn’t apply to the latest edition of your favorite gaming system, limited tickets to a sporting event, or a last-minute beach retreat with your friends. You can save up for those expenditures, but it should be done in your regular savings, not your emergency fund.
Not replacing withdrawals
When you dip into your emergency fund for a qualifying expense, don’t forget to replace that money when you can. By doing so, you’ll stay on track for reaching your savings goal, which helps make sure you’ll have that money when you need it again.
Stopping when you reach your initial goal
Reaching your initial goal for your rainy-day fund will be a major milestone that you should celebrate. However, once you do, take the initiative to set a new savings goal. After all, you don’t know what the future will bring, so the more money you set aside in your emergency fund, the better prepared you will be. Also, this ensures you won’t need to divert savings from your traditional savings account, so you can use those funds for the things you really want.
The bottom line
Starting an emergency fund can seem daunting, especially if money is tight, but it doesn’t have to be. Setting a goal for your emergency savings and creating a plan to achieve that goal goes a long way in making your emergency fund a reality. You'll be surprised at how quickly your balance grows by budgeting how much you can put into your rainy-day fund and using savings tools such as automatic deposits and round-up programs.
Finding the right place to keep your emergency fund to take advantage of additional savings through earned interest also is key to achieving your savings goal. Of course, avoiding mistakes such as spending your emergency funds on non-emergency purchases also will go a long way in helping you build your emergency savings.
At first, it might seem like a struggle to start and build an emergency fund, but when you have the money you need when surprise expenses hit, you’ll be both relieved and proud of your accomplishment.
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Writer
Karon Warren is a freelance writer who has covered articles in finance, insurance and health for sites like Reviews.com, USA Today, Healthgrades, among others.
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