What is an Emergency Fund?

Emergency Fund Emergency Fund Series

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An emergency fund can be hard to accumulate, but of all the items in your financial tool kit, it could be the most important.

After a medical emergency or hardship due to income loss, your emergency fund can be a lifeline. And given the current economic fallout from the COVID-19 pandemic, it’s more important than ever to have a safety net to fall back on in the face of financial distress.

“Unplanned expenses can happen at any time, and nothing helps you sleep better at night than knowing you have some money put away just in case,” says Greg McBride, CFA, chief financial analyst at Bankrate.com. 

But for many Americans, the reality is much less certain.

According to data from the Federal Reserve, nearly four in 10 Americans would be unable to cover an unexpected expense of $400 with cash or its equivalent. And new data show that 40% of households making less than $40,000 per year suffered a job loss in March.

But you don’t have to wait for an economic rebound to begin saving money. Even if you’re already facing income disruption or financial hardship, you can begin setting aside cash for the future.

This guide will help you make the most of an emergency fund — from determining how much cash to save to deciding how and when to use your savings. Here’s how to best make your emergency fund work for you.

Emergency Fund Basics

You might already have a traditional savings account to which you contribute a few dollars when it’s convenient or even a dedicated fund to save up for your next dream vacation or down payment. 

But rather than another account you dip into occasionally for nonessentials, your emergency fund should be a designated reserve of up to several months’ living expenses kept in a safe, accessible account that you only withdraw from in case of emergency.

In other words, it’s a safety net. 

Some experts recommend just $1,000 to begin, while others may advise you to save a year’s worth of expenses. Most often, emergency savings recommendations range from three to six months of living expenses. 

Only you can judge the right amount for you, though. Consider your current income and job stability, your expenses, debts, future plans, and various other factors that make up your overall financial outlook, then continue to readjust your priorities over time.

Expecting the Unexpected: Why You Need an Emergency Fund

Putting off those extra savings contributions may be easy when times are good, but the true value of your emergency fund may become clear only when you need it.

“Sometimes the emergency fund is necessary because you slipped down the steps and need care in your home,” says Jill Schlesinger, CFP, host of the “Jill On Money” podcast. “Or a pandemic hits and the job that you thought was secure isn’t so secure.” 

According to the Urban Institute’s research, 25.7% of families suffer at least one of three types of income disruptions each year. These disruptions include an income drop of 50% or more, health-related work limitations, or involuntary job loss. 

And in a post-pandemic world, that reality is even more stark for many Americans.

“For a long time, it was hard to convince people that they needed an emergency fund,” says Liz Plot, CFP, associate financial planner at Ballast Point Financial Planning in Columbia, Maryland. But a silver lining to the gravity of the current situation could be an increased willingness to take action. Now, she says, “no explanation is necessary.” 

But the situation doesn’t always have to look so dire for you to benefit from an emergency fund. Your emergency fund may also be helpful for unexpected opportunities. 

“Maybe it’s something really random,” Schlesinger says. “Imagine you have this fantastic opportunity that requires a move across the country, but you don’t have the money to move because you don’t have the funds available.” 

With an emergency fund, you don’t have to compromise.

The Dangers of Being Unprepared

If you’re already short on cash, even a single unexpected expense could adversely affect your overall financial health.

The 2019 Federal Reserve report on the economic well-being of U.S. households indicates that among those who could not cover an unexpected $400 expense with cash, the most common alternative methods include carrying a balance on a credit card or borrowing money from friends and family.

Developing a habit of taking on debt can not only negatively impact your long-term financial health but also result in a much greater balance over time due to high-interest accrual. This is especially true for credit card interest on balances, which currently averages at above 16%.

Is Now a Good Time to Begin Saving?

Ideally, your emergency fund would have time to grow before you experience an emergency. But as the financial crisis continues to impact more Americans, it’s more important than ever to set aside whatever you can for income loss, medical bills, and essential expenses.

Don’t feel overwhelmed if six months’ worth of living expenses feels like an unattainable goal right now. Start small.

Your goal is a destination, not a starting point, McBride says. Successful saving is all about the habit, so your primary focus should be on simply establishing this habit.

Pro Tip

Especially in the midst of a crisis, it’s OK to work slowly but surely toward a modest goal designed to help you reach the other side on solid footing.

Small Amounts Can Make a Difference

If you still have a stable income, set aside what you can after your necessary expenses are paid each month. If you don’t have cash coming in at the moment, even a few dollars set aside for the future is better than nothing. Consider moving money you may receive via stimulus check or tax refund into your emergency fund, as well. 

Any funds previously designated for spending on discretionary activities you’re unable to participate in now anyway, such as a gym membership and eating out, can also make a big difference in your savings total. 

The most important thing is to get started. Even if you’re only able to contribute a few dollars each month, that sum will add up over time. 

According to research from the Urban Institute, consumers with savings of even just $250 to $749 are “less likely to be evicted, miss a housing or utility payment, or receive public benefits after a job loss, health issue, or large income drop.” 

Bottom Line 

“The most important aspect of an emergency fund is in its name,” Schlesinger says. “It’s there for you in an emergency.”

Take the time to personalize your savings goal and establish your fund using strategies that work for your own budget and financial situation. Establishing an emergency fund and continuing its growth over time can help you feel more secure during times of uncertainty and better prepared for your financial future.

Continue this guide to learn more about where to stash your emergency fund, how to determine a savings goal, and alternatives to consider when facing hardship.

Emergency Fund Up next in the Emergency Fund series