Emergency Fund: What It Is And How To Start One

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

What is an emergency fund?

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

Unforeseen medical bills.
Home appliance repairs or replacements.
Major car fixes.
Unemployment.

Why do I need an emergency fund?

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

» MORE: How to Get Out of Debt

How much should I save?

The short answer: If starting small, try to set aside at least $500, but work your way up to 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. (For example, you might need more if you freelance, work seasonally 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.

The most important thing is just to start building an emergency fund, however small it is. Having even $500 saved can get you out of many financial scrapes. Put something away now, and build your fund over time.

» MORE: Tracking monthly expenses: The first step to money success

Where do I put my emergency fund?

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-interest savings account is a good place for your money. These accounts typically earn much more interest than everyday accounts You can access your cash quickly when needed, whether through a withdrawal or a funds transfer.

How to build an emergency fund

Calculate the total that you want to save

If you’re unsure where to start, write down all your expenses in six months, and use that as a guide.

Set a monthly savings goal

This will get you into the habit of saving regularly and will make the task less daunting. One way to do this is by automatically transferring funds to your high-interest savings account each time you get paid.

Move money into your savings account automatically

If your employer offers electronic payments there’s a good chance they can divide your paycheque between multiple everyday and savings accounts so that your monthly savings goal is taken care of without touching your everyday account.

Keep the change

Round-up apps, like Wisr, do exactly that: round up the purchase amounts on your transactions and automatically transfer the extra amount to a savings account. Let’s say you buy something that costs $9.80 — the app will deposit 20 cents into your savings account.

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.

Assess and adjust contributions

Check in after a few months to see how much you’re saving, and adjust if needed, especially if you recently withdrew money from your emergency fund. On the other hand, if you’ve saved up enough to cover six months of expenses and have extra cash, you might consider investing the additional funds instead.

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 savings account for irregular but inevitable items, such as car maintenance, holidays and clothing. If you need help staying organised, many banks allow customers to create and label sub-accounts for different financial goals.

» MORE: Discretionary spending: The extras, not essentials

If you’re in the United States, read this article on the NerdWallet US site.