The Big Question Every Good Emergency Fund Starts With

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Each time you establish a new healthy habit, you’ve got to start somewhere.

Your emergency fund is no exception — stowing away up to a year’s worth of expenses for an unforeseeable future hardship probably sounds daunting, if not completely implausible. But while you should have a long-term savings goal in mind, even just a few extra dollars each paycheck can help you feel more secure in the face of an emergency. 

“That’s why it’s important to establish the habit,” says Greg McBride, CFA, chief financial analyst for Bankrate.com. “You’re not going to get there right away.”

What’s more important than where you finish is simply establishing an account you contribute to regularly, which could make all the difference in keeping you from delinquency or high-interest debt balances in times of financial hardship.

Here are some tips for setting up your emergency savings to ensure your financial security has a solid foundation.

How Much Money Should You Keep in Emergency Savings?

Expert recommendations for how much cash to keep in an emergency fund fluctuate. You can find compelling arguments for totals ranging from $1,000 to more than a year’s worth of expenses. 

Generally, about six months’ worth of living expenses is a good rule of thumb. But your emergency fund will serve your individual needs much more thoroughly if you take the time to work out an attainable goal aligning with your income and expenses, then adjust over time.

Set a Savings Goal

Since the loss of income is one of the most compelling reasons to dip into an emergency fund, consider keeping the equivalent of a few months’ expenses rather than a specific amount.

For instance, if you have relative job security and no current debts, one to three months’ expenses could be sufficient. If your income source is more volatile — maybe you’re a project-based freelancer or work in an industry directly impacted by COVID-19 — a goal of saving between six months and a year’s worth of expenses may offer you more security.

Remember to keep your goal realistic, though. You likely won’t be able to save several months’ worth of expenses overnight, and reaching that goal at all may seem overwhelming. Instead, start with a smaller, shorter-term goal and increase your savings over time.

Evaluate Your Expenses

After deciding how many months’ worth of expenses to keep in your emergency fund, you’ll need to determine what exactly that entails.

Consider where exactly your money goes once it’s deposited into your account. You probably dedicate a large percentage to recurring monthly expenses, like rent or mortgage payments, utilities, and food, and reserve the rest for discretionary spending.

Determine which of these expenses you’d deem essential during an emergency, and use it to inform your savings goal. And given the recreation, retail, and restaurant closures resulting from the pandemic, now may be more convenient than ever to complete these calculations.

If you’ve been forced to cut back on discretionary spending back over the past few months, you may now have a clearer idea of your necessary spending during a crisis, which you can use to estimate your savings goal better.

Revisit Your Plan

After you’ve successfully begun making regular savings contributions or met your first short-term savings goal, take some time to go over your plan and reconsider whether it’s still the best fit.

If everything is going smoothly, you may decide you want to push yourself and increase your goal by 10 or 15%. Alternatively, if you’re not on track to save what you predicted, it may be time to revisit your budget and expenses.

And any time your situation changes, reconfigure your savings plan once again. Changes in life circumstances will necessitate a change in your savings. This adjustment could be following an income change after having kids or even when approaching retirement.

“It doesn’t matter if you’re retired, you still need an emergency fund,” says Liz Plot, CFP, associate financial planner at Ballast Point Financial Planning in Columbia, Maryland.

“Things come up — a car repair, a death in the family, job loss. The idea is to have that emergency fund, use it for that emergency and then build it back up.”

Regularly reevaluating your savings goal will ensure your savings remain aligned with your evolving expenses and keep your safety net growing with you over time.

Pro Tip

Determine a savings goal, pick an account that suits your needs, and adjust as needed over time.

Where and How Should You Keep Your Emergency Fund?

It may seem like a small detail, but the account in which you keep your emergency fund can have big implications for your savings.

You’ll want to pick somewhere accessible, so you’re able to use your money in case of an emergency. But making it too available, like under your mattress or in your checking account, could lead to temptation.

“If you find yourself raiding it every Friday night to have fun on the weekend, you’re just going to be spinning your wheels,” McBride says.

Most importantly, you should pick a safe place where you don’t have to worry about fluctuations and risks. A high-risk investment account is not likely to serve you well in an emergency.

Here are a few types of safe, accessible accounts to consider: 

High-yield savings account

“An online savings account is really the best place for the money,” McBride says. “You can get to it easily by linking it to your checking account at your current bank or credit union, have the protection of federal deposit insurance, and the return is better than you’re going to earn on any comparable savings vehicle.”

A high-yield savings account — which typically yields around 1.5% APY (annual percentage yield) today — can help you earn modest interest on your savings and ensure easy access to funds. 

These accounts are offered by both online and brick-and-mortar banks and often include low or no fees and low minimum deposits. 

Money market account

Money market accounts are similar to high-yield savings accounts when it comes to low fees and interest earnings. 

However, money market accounts typically include debit cards or paper checks, so you can take out the money without transferring it to another account. This step can be helpful in a true emergency but it could be risky if you’re afraid of overspending.

Depending on the bank, money market accounts may also require a higher minimum deposit upon opening. If your short-term plan is to save just a few dollars each month toward your emergency fund, consider waiting to open a money market account later on, once you’ve built up a larger safety net.

Certificate of deposit

CDs are much less liquid than a high-yield savings or money market account, but they do typically offer higher interest earnings.

“You’re committing your money for a period of time, and there’s an early withdrawal penalty,” McBride says. “That’s not ideal for your emergency fund, and it’s certainly not a starting point for your emergency fund.”

But they could be a supplement, he said. For instance, you could keep three months’ worth of expenses in a high-yield savings account, then stash the rest of your 12-month emergency fund in laddered CDs to maximize your earnings.

Traditional savings account

Keeping your emergency savings in a traditional, low-yield savings account can simplify the process — it’s usually easy to open an account with the same bank or credit union with which you already have a checking account. But you will likely forfeit some interest earnings.

Be mindful to ensure you’re not tempted to spend your emergency savings if you choose this account. According to Plot, “It’s good to keep it at a different bank than you normally bank with; it’s out of sight, out of mind so you’re not tempted to use it and it really is just for emergencies.”

Why This Matters

Building your emergency fund atop a solid foundation will allow you to feel secure no matter what obstacles come your way over time. And when the time comes when you need assistance making payments for a few months or you get billed for a new car engine, you’ll be glad you have a cushion.

Continue to the next part of this guide for actionable steps to simplify your monthly savings and build your emergency fund.