In the wake of the global Covid-19 pandemic, we’ve all learned to expect the unexpected. Yet according to a 2024 survey from Empower, nearly 37% of Americans aren’t prepared to handle a $400 emergency expense.
These days it doesn’t take much to hit that relatively low threshold. A fender bender, a bad fall, or a power outage is all it takes—and when interest payments are factored into the equation, you stand to lose more and more over time. That’s why everybody needs an emergency fund set aside to pay for life’s unexpected expenses.
“The purpose of an emergency fund is to provide you with the confidence and stability to handle life's unpredictability without resorting to high-interest debt or sacrificing long-term financial goals,” says Jennifer Kohlbacher, CPA, director of wealth strategy at Mariner Wealth Advisors.
Unlike other savings goals that often have a single defined end point—like home ownership or retirement—an emergency fund is meant to be maintained for the long term and utilized over and over again. Let’s take a look at what you need to build an emergency fund that lasts.
Why do you need an emergency fund?
We’ve all faced a situation like this: One fine morning your car won’t start. That means paying for a rental, having your car towed to the garage, and shelling out for expensive repairs. Inevitably, you pay a premium because of the time crunch. Now you’re out thousands, and catching up feels impossible.
According to Kohlbacher, an emergency fund is designed to prevent situations like this from completely disrupting your financial life. “In 2020 I faced several unexpected major expenses, including the need to replace my home's air conditioning, refrigerator, and stove,” she says. “Having an emergency fund in place during such unpredictable times gave me peace of mind as these costs emerged. Additionally, the fund motivated me to carefully review and adjust my family's spending goals and budget to stay on track financially.”
5 easy steps to build an emergency fund
The path to building an emergency fund is going to look different for each household. The amount you set aside, where you save the money, and when you tap the fund all depend on your budget and personal preferences, but here are five simple steps everyone should follow to get started.
1. Build a budget first
According to the Empower survey, only 14% of Americans are regularly saving for a rainy day. In many cases, a big reason for this gap is the lack of a well-planned budget. Sure, you might want to read just about anything else besides budget advice, but bear with me.
There are plenty of budgeting methods that can give you a solid handle on your finances without causing undue stress. Take the very intuitive 50/30/20 budget, which calls on you to divide your income into three buckets:
- 50% should be spent on essential expenses
- 30% should cover on non-essential spending
- 20% should go into savings
Look over your most recent pay stubs to see how much you bring home each month. List out your essential expenses—housing, transportation, groceries, utilities, debt payments—as well as your discretionary spending. Keep in mind that the percentage figures are general benchmarks, not inflexible budget demands.
Let’s say you earn $55,000 a year, and net $3,375 per month after taxes and benefits. Suppose your essential monthly living expenses add up to $1,625, just shy of the 50% benchmark. Your non-essentials might add up to something like $1,000, about 30% of take-home pay. That leaves you with about $750 in discretionary income each month.
Let’s use that discretionary income to figure out how much to save in the next step.
2. Plan out your savings goal
There’s no one-size-fits-all savings goal for everyone, says Alex Michalka, Ph.D. and VP of Investment Research at Wealthfront. “Your emergency fund should cover three to six months’ worth of living expenses. This financial cushion provides flexibility in case of job loss, medical emergencies, or other unexpected expenses,” he says.
This might sound intimidating, but don’t fret. Michalka adds that it's okay to start small; You could create a starter emergency fund of $500, for example, and build up from there. “Any emergency fund is better than none,” she says.
If you’ve got $750 in discretionary income each month, you might put a portion of that into a Traditional IRA to plan for retirement ($150), designate some for future expected expenses such as new tires or a replacement appliance ($100), and put the rest ($500) in your emergency fund.
If your goal is to build a $5,000 emergency fund, you’ll hit that amount in 10 months. Double that for a $10,000 emergency fund. Divide your emergency fund goal by the amount you want to set aside each month to figure out how long it will take to save the money.
3. Segregate your emergency fund from everyday funds
A major issue many people run into when trying to establish an emergency fund is a lack of separation from their everyday finances. Solve for this by opening an easily accessible account, where you can make a withdrawal quickly but not spend the money on accident.
In most cases, this will mean shopping around for an account that doesn’t charge monthly fees, doesn’t require a minimum balance requirement, and carries a decent interest rate so your fund can grow in between your contributions. Generally speaking, a free high-yield savings account will suffice.
Derik Farrar, Head of Personal Deposits at U.S. Bank, points out that ambitious earners may prefer to get certificates of deposit (CDs) or open a money market account (MMA). Keep in mind though that funds in these types of accounts may not always be accessible without penalty.
4. Set up automatic transfers to your account
Once your account is open, you’ll want to be disciplined about maintaining the plan you made in step two.
In our example above, your goal is to save $500 a month—so you might save $250 per pay period. You can sometimes set up direct deposit so that a portion of your paycheck goes straight to savings, or you can set up automatic transfers to move money from your checking account to your savings.
Want to step it up a notch? Look for more ways to save. Your annual tax refund, work bonuses, or income from side gigs can all go straight to your emergency fund account to help it to grow more quickly.
5. Continue saving once you reach your goal
Congratulations, you’ve got a plan to fully stock your emergency fund and you never have to worry about finances again! Sorry, but it’s not that simple. Life constantly throws curveballs, and you’ll need to fund to dodge them over and over again. There will always be more expenses you’ll be facing.
With a solid safety net in place, you can focus on saving for the expected expenses of life, such as:
- Setting up another savings goal, such as a vacation or a home down payment
- Saving more for retirement
- Adding to the fund if your living expenses increase, or you work in a high-risk industry where you might be worried about job security
So you’ve paid for an emergency—now what?
Your emergency fund is there when you need it—but what constitutes a need? There are a few questions you might ask yourself before tapping into your safety net:
- Can I survive without this? If yes, it’s not a true emergency.
- Do I have any other way to pay for this? Perhaps you can sell something, or pick up an extra shift to earn the funds quickly.
- Is there any way to lessen the blow? If it’s possible to set up an interest-free payment plan, you may be able to spread out the cost rather than it hitting all at once.
The bottom line
Saving up for a rainy day doesn’t need to be an impossible task. Yes, it can be challenging, especially with the costs of goods and services seeming to rise on a daily basis. But some careful planning can go a long way, and you don’t have to commit to saving a full three to six months of expenses right away. Start with a smaller amount, even just $500, and you’ll be well on your way to building a more secure financial future.
Kim Porter contributed to this article.
