Emergency Fund: What It Is and Why It Matters

An emergency fund is a bank account with money set aside to pay for large, unexpected expenses, such as:

• Unforeseen medical expenses.

• Home-appliance repair or replacement.

Emergency funds create a financial buffer that can keep you afloat in a time of need without having to rely on credit cards or high-interest loans. It can be especially important to have an emergency fund if you have debt, because it can help you avoid borrowing more.

The short answer: If you’re starting out, try to set aside an amount that would cover an important bill, say $500. But keep working your way up. You’ll want to max out at about half a year’s worth of expenses.

The long answer: The right amount for you depends on your financial circumstances, but a good rule of thumb is to have enough to cover three to six months’ worth of living expenses. (You might need more if you freelance or work seasonally, for example, or if your job would be hard to replace.) If you do lose your job, you could use the money to pay for necessities while you find a new one, or the funds could supplement your unemployment benefits.

Having savings can get you out of many financial scrapes. Put something away now, and build your fund over time.

Ideally, you’d put your emergency fund into a savings account with a high interest rate and easy access. Because an emergency can strike at any time, having quick access is crucial. So it shouldn’t be tied up in a long-term investment fund. But the account should be separate from the bank account you use daily, so you’re not tempted to dip into your reserves.

A high-yield savings account is a good place for your money. It is federally insured up to $250,000 per depositor, per ownership category, per financial institution so it’s safe. (Read more on how savings accounts are federally insured through the Federal Deposit Insurance Corp., or FDIC, and the National Credit Union Administration, or NCUA.) In addition, the money earns interest, and you can access your cash quickly when needed, whether through withdrawal or a funds transfer.

While a savings account is an excellent option, some people may not be able to open one immediately. If a bank closed a previous account of yours, for example, it may have reported the closure to a consumer reporting agency, such as ChexSystems. That can prevent a new bank from approving your account application. If that’s the case, you have options. You can work with the agency to resolve the outstanding issues. At the same time, consider opening a second chance checking account. After a few months building a positive banking history, you’re more likely to be able to open a solid interest-earning account.

2. Set a monthly savings goal. Instead of focusing on one large savings goal, focus on smaller, attainable monthly goals. Reaching monthly milestones can give you positive momentum and encourage you to keep saving. This can help you keep the habit of saving regularly and make the overall task less daunting.
   

3. Move money into your savings account automatically. If your employer offers direct deposit, ask if they can divide your paycheck between checking and savings. That way your monthly savings goal can be taken care of without the funds touching your checking account.
   

4. Keep the change. Use mobile technology to save automatically each time you make a purchase. There are savings accounts and savings-focused apps that link with checking or other spending accounts to round up the purchase amounts on your transactions. The extra amount is automatically transferred to a savings account.
   

5. Save your tax refund. You get a shot at this once a year — and only if you expect a refund. Saving it can be an easy way to boost your emergency stash. When you file your taxes, consider having your refund deposited directly into your emergency account. Alternatively, you can consider adjusting your W-4 form so that you have less money withheld. If modifying your deductions is a good option for you, you can direct the extra cash into your emergency fund.
   

6. Assess and adjust contributions. Check in after a few months to see how much you’re saving, and adjust if needed. When you’ve saved up enough to cover six months of expenses, you might consider putting extra cash in investments.

When saving, draw a line between emergencies and everything else. In fact, once you’ve hit a reasonable threshold of emergency savings, it’s a good idea to begin another “rainy day” savings account for irregular but inevitable expenses, such as car maintenance and clothing. If you need help staying organized, consider opening separate savings accounts or subaccounts for different financial goals.

Everyone needs to save for the unexpected. Having something in reserve can mean the difference between weathering a short-term financial storm or going deep into debt.

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