6 second take: If you don't have an emergency fund, you need to start one asap. Here’s how.
One of the first steps on the road to financial freedom is to build an emergency fund.
What is an emergency fund? It’s a pool of savings that you use to pay for major unexpected expenses. Typical emergencies you might address with an emergency fund include your auto insurance deductible after a car accident and paying living expenses for a short period after a job loss.This is an extremely important resource to have.
When an emergency strikes, our emotional focus is naturally on the crisis, not on its financial ramifications. A big emergency has us go all-out mentally and emotionally to confront the problem. Finances tend to get relegated to the back burner. This can lead to poor financial management during the crisis, costing us money in the long run.
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How Much to Save
There is no set answer to how much. Financial advisers typically recommend three to six months’ worth of living expenses (which should be somewhat less than your take-home pay). This is a fine starting point, but don’t get hung up on the number. Having something is better than having nothing saved for an emergency, which is where many people are at.
Don’t procrastinate trying to calculate an ideal number. Just start saving in a separate account to build an emergency fund.
There are a couple of big considerations in determining which end of the three- to six-month spectrum you should be on.
Income is one consideration. For example, if you’re a two-earner household with high-income, secure jobs and no other dependents, perhaps three months is sufficient. If you have some risk of a layoff, downsizing, or other potential interruption in income, perhaps you should lean toward the higher end.
Dependents who don’t earn a wage should factor into the equation, as well. They are a potential source of an emergency, not to mention a continuing expense should you lose your income. You should consider having a larger emergency fund if you have dependents than if you don’t.
Where to Keep an Emergency Fund
There are two overriding factors for determining where to keep an emergency fund: stability and accessibility. Return isn’t as important. Use it as a tie-breaker if you wish, but don't treat it as a primary concern.
Stability is the number-one consideration. Your emergency fund needs to be completely available when an emergency occurs, and it shouldn’t be subject to market variations. This means that extremely stable places like savings accounts and money markets are the best options.
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Accessibility is the second factor. Some emergencies require immediate attention. This means that your funds need to be immediately available — within reason. Since a three- to six-month reserve is supposed to fund both routine and extreme emergencies, 100 percent of the fund doesn’t need to be immediately available. If you have 20 percent available immediately, and the rest is available in two to three days, that’s fine.
You can also consider investments like CDs for a portion of your emergency fund. Most CDs have a premature withdrawal penalty. Typically, the penalty is forfeiture of some or all of your interest.
Many advisers suggest not using CDs for an emergency fund due to the possibility of incurring this penalty.
But if half of your fund is available without penalty, you would only risk occurring the penalty in the event of an extreme emergency. The rest of the time, you would earn higher interest than sitting in a regular bank account. The vast majority of the time, you win.
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How to Build an Emergency Fund: Getting Started
It’s actually quite simple. To get started, you should have a dedicated account for your emergency fund and an automatic method of funding it.
Start now, even if you haven’t figured out exactly how much or how you plan on structuring it. You can make those decisions later. For now, the most important thing is to get started. Otherwise you’ll never get there!
Consider opening a separate savings account at a local bank, a credit union, or even an online bank. Make sure that it’s an account that you can fund automatically and direct money from each paycheck into it. Start with what you can afford. Keep increasing it until you get where you want to be.
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Also consider adding lump sums if money becomes available (from a tax refund, for example). Adding even a portion of your tax refund into your emergency fund can really jump-start your funding.
Hopefully you won’t need this fund often. But the peace of mind that comes from not needing to worry about where you’re getting the money to pay for a crisis is simply priceless.
FAQs
While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months' worth of expenses.
How much money do you need to build an emergency fund? ›
While the size of your emergency fund will vary depending on your lifestyle, monthly costs, income, and dependents, the rule of thumb is to put away at least three to six months' worth of expenses.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals.
How should I build my emergency fund? ›
Aim to save three to six months' worth of living expenses and consider automating your savings through direct deposit or savings apps. Start small and make it a priority to build your emergency fund, as it can make all the difference in times of financial uncertainty.
Is $5,000 enough for emergency fund? ›
Saving $5,000 in an emergency fund can be enough for some people, but it is unlikely sufficient for a family. The amount you need in your emergency fund depends on your unique financial situation.
Do 90% of millionaires make over $100,000 a year? ›
Choose the right career
And one crucial detail to note: Millionaire status doesn't equal a sky-high salary. “Only 31% averaged $100,000 a year over the course of their career,” the study found, “and one-third never made six figures in any single working year of their career.”
Is a $20000 emergency fund good? ›
A $20,000 emergency fund might cover close to three months of bills, but you might come up a little short. On the other hand, let's imagine your personal spending on essentials amounts to half of that amount each month, or $3,500. In that case, you're in excellent shape with a $20,000 emergency fund.
How much should a 30 year old have saved? ›
Fidelity Investments recommends saving 1x your salary by 30. At the end of 2021, the average annual salary was $49,920 for 25 to 34-year-olds and $58,604 for 35 to 44-year-olds. So the average 30-year-old should have $50,000 to $60,000 saved by Fidelity's standards.
How to budget $5000 a month? ›
Consider an individual who takes home $5,000 a month. Applying the 50/30/20 rule would give them a monthly budget of: 50% for mandatory expenses = $2,500. 20% to savings and debt repayment = $1,000.
How to budget $4000 a month? ›
making $4,000 a month using the 75 10 15 method. 75% goes towards your needs, so use $3,000 towards housing bills, transport, and groceries. 10% goes towards want. So $400 to spend on dining out, entertainment, and hobbies.
As of May 2023, more than 1 in 5 Americans have no emergency savings. Nearly one in three (30 percent) people in 2023 had some emergency savings, but not enough to cover three months of expenses. This is up from 27 percent of people in 2022. Note: Not all percentages total 100 due to rounding.
What is a realistic emergency fund amount? ›
To prepare for income shocks, many experts suggest keeping enough money in your emergency fund to cover 3 to 6 months' worth of living expenses. So if you spend $5,000 per month, your first emergency fund savings milestone should be $2,500 to cover spending shocks.
Is a millionaire's best friend? ›
Here's a little secret: compound interest is a millionaire's best friend.
How much should a 23 year old have saved? ›
Aim to have three to six months' worth of expenses set aside. To figure out how much you should have saved for emergencies, simply multiply the amount of money you spend each month on expenses by either three or six months to get your target goal amount.
How can I double $5000 dollars? ›
To turn $5,000 into more money, explore various investment avenues like the stock market, real estate or a high-yield savings account for lower-risk growth. Investing in a small business or startup could also provide significant returns if the business is successful.
Is $100 K too much for an emergency fund? ›
It's important to have cash reserves available, but $100,000 may be overdoing it. It's important to have money available in your savings account to cover unforeseen expenses. Plus, you never know when you might lose your job or see your hours (and income) get cut, so having cash reserves at the ready is important.
Is $10,000 too much for an emergency fund? ›
Those include things like rent or mortgage payments, utilities, healthcare expenses, and food. If your monthly essentials come to $2,500 a month, and you're comfortable with a four-month emergency fund, then you should be set with a $10,000 savings account balance.
Is $500 enough for an emergency fund? ›
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.
Is $1,000 enough for emergency fund? ›
If you have any debt other than a mortgage, then you just need a $1,000 emergency fund—aka a starter emergency fund. We call this Baby Step 1. It's the first piece of your money journey, so don't skip over it. That starter emergency fund sets you up to begin paying off your debt—that's Baby Step 2.
There is no set answer to how much. Financial advisers typically recommend three to six months’ worth of living expenses (which should be somewhat less than your take-home pay). This is a fine starting point, but don’t get hung up on the number. Having something is better than having nothing saved for an emergency, which is where many people are at.