What Is an Emergency Fund? How to Prepare for Financial Surprises

Unless you can predict the future, it’s wise to have an emergency fund. Even a couple hundred dollars in savings can help you avoid taking on high-interest debt when financial emergencies pop up.

But setting cash aside is easier said than done. Only 44% of US adults would pay an emergency expense of $1,000 or more from their savings, and 35% would borrow money, including 21% who would finance an emergency expense with a credit card, according to Bankrate’s annual emergency savings report. The biggest culprit? Inflation. Nearly 2 in 3 Americans say high inflation is causing them to save less. 

However, as inflation starts to cool, now’s a great time to revisit your budget to see if there’s any money you can free up for savings. Even starting small can help you take advantage of high interest rates while they are still around. 

Here’s everything you need to know about an emergency fund -- how to build one, the benefits, how much to save and the best places to grow your money.

What is an emergency fund?

An emergency fund should not be confused with an account you dip into occasionally for nonessentials. Your emergency fund should be a designated reserve of several months’ worth of living expenses kept in a safe, accessible bank account that you only withdraw from in case of emergency.

You might already have a savings account you contribute a few dollars to occasionally, or even a dedicated fund to save up for a down payment on a home or dream vacation. But your emergency fund is a safety net in a precarious situation. 

“Unplanned expenses can happen at any time, and nothing helps you sleep better at night than knowing you have some money put away just in case,” says Greg McBride, chief financial analyst at Bankrate, CNET’s sister site.

How does an emergency fund work?

You may not think about your emergency fund much when you’re doing well financially, but its true value becomes clear when you need it.

The reality is, “you’ll have good years and bad years,” says Niv Persaud, founder and managing director of Transition Planning and Guidance. “So, you really have to look at your long-term goals.”

It can be difficult to think about the possibility of a medical emergency or a layoff, but it’s also reassuring to know you have the money in case you need it. You have to think not just about now, but how you envision your life in the future, added Persaud. 

The situation doesn’t always have to look so dire for you to benefit from an emergency fund. Your emergency fund is also helpful for unexpected opportunities, finding financial peace and reaching big life goals. 

“Reducing expenses and increasing the gap between your earnings and your expenses is how you build wealth and actually enjoy today and tomorrow more,” says Jeremy Schneider, founder of Personal Finance Club. “While I love talking about building wealth before you can do that, you need a financial foundation on which you can build.”

Seven common situations that qualify as financial emergencies include the following:

• Job loss or income loss.
• Medical emergencies.
• Unexpected home repairs.
• Car maintenance and repairs.
• Urgent pet care.
• Family emergencies.
• Unexpected tax bills.

How much money should I save in an emergency fund?

Experts have different opinions on how much you should have in your emergency fund. Most recommend saving three to six months’ of living expenses. But like any financial decision, you should only commit to a goal that complements your budget and makes you feel secure. 

“A good rule of thumb for most people would be to have three to six months of must-have expenses,” says Shang Saavedra, a personal finance blogger and founder of Save My Cents. “But if you already have credit card debt, even one month of expenses is good enough. The goal is really to break the paycheck-to-paycheck cycle.” 

Your financial outlook is based on several factors and will change a lot over your lifetime. The number that makes you feel secure now is most likely not going to be the same 10 or 20 years down the line. And the number you need to feel secure now likely won’t match the number that makes sense for your neighbor or best friend at the office.

How to build an emergency fund

The first step to building your emergency fund is saving. Savings contributions aren’t as glamorous as massive returns on investments, but they are crucial to your financial health.

Think about it like this: You don’t have to save, you get to. “The concept of having money set aside is such a privilege,” says Jannese Torres, money coach and founder of Yo Quiero Dinero.

When building an emergency fund, one of the first steps is to figure out how much money you need to save. This will help you set up a realistic goal. Then you can take some steps to make the saving process more manageable.

• Automate your savings: If it’s available to you, automate everything you can, even beyond savings. If you’re constantly forgetting to pay your credit card bill or other important payments, autopay can help you avoid going into debt or adding to it. Another way to save automatically is through your employer. Some employers let you split your paycheck between your checking and savings accounts automatically. Most savings accounts also let you set up automatic savings rules to move money from checking to savings each time you get paid.
• Manage debt while saving: It’s important to find a balance between saving and managing your debt. You might split your goals between building an emergency fund and paying down your debt. Just make sure to at least pay the minimum on your debt accounts to avoid penalties. As your debt decreases, you can adjust your priorities.
• Monitor your progress regularly: One of the best ways to stay on track is to track your progress. This is especially important if you’re easily motivated by goals. Hitting the first $500 in your savings account might encourage you to save more aggressively, if you’re able to. And, if you hit a roadblock, you can make adjustments along the way.
• Take advantage of one-time opportunities to save: When you get a tax refund, bonus or other one-off payments, funnel some of those funds into your emergency fund.
• Cancel subscriptions and memberships: Getting rid of unwanted subscriptions and memberships you no longer need can be a painless way to free up money for your emergency fund. And, if you want to keep a subscription, check your credit cards or phone plan to see if the service is offered for free as part of a membership benefit. 
• Earn extra income: If you want more of a cushion in your savings account, you might consider ways to earn extra income, like picking up a side hustle.

When to use your emergency fund

You should use your emergency fund when you need to, but not necessarily every time you want to. Once you’ve established your emergency fund, you’ll have to make the decision of when to use it over time. Sometimes the decision is simple, but other times it’s not as clear. 

“One of the challenges for people who never had savings, but have now built an emergency fund, is giving themselves permission to use it,” says Summer Red, director of education at the Association for Financial Counseling and Planning Education. “The emergency comes and the thought of spending all they’ve saved is really traumatizing.” 

At the end of the day, your emergency fund is designed to safeguard your financial health. Don’t go into debt or borrow money to cover essential expenses that your emergency fund could cover.

“It’s there for medical emergencies, loss of income, those sorts of things,” says Todd Christensen, author of Everyday Money for Everyday People. “It’s not for social emergencies, like going out with your friends or taking a vacation. You need to plan for all these other things outside of emergency savings.”

The decision to tap into your emergency fund should be based on your current financial situation.

What are the benefits of an emergency fund?

Compared to other savings strategies, you don’t need to earn a certain amount of interest on the money you set aside in an emergency fund. The simple act of saving money can provide significant financial benefits, including the following:

• Keeping you out of debt: An emergency fund will help you avoid dipping into a line of credit or getting a loan when you need to cover an unexpected expense. 
• Providing peace of mind: Knowing that you have savings available can help you feel better prepared to handle an unexpected financial obstacle. Even if you don’t use your emergency fund, it can give you a sense of financial stability.
• Financing an unexpected job loss: If an emergency such as a job loss means you’ll be without a paycheck for a period of time, your emergency fund can help you cover your expenses.
• Helping you make better financial decisions: When an unexpected expense comes up, it’s easier to navigate with an emergency fund. The stress of figuring out how to pay can make you more likely to agree to high interest rates and other unfavorable terms. But with an emergency fund, you’ll be free to explore your options and make a more informed decision.

Do I really need an emergency fund?

While it can be overwhelming to think about compiling several months’ worth of expenses in the event of an emergency, the peace of mind it brings pays in dividends. 

Emergency funds are a way to prepare for the unexpected. If you’re already short on cash, a single surprise could adversely affect your overall financial health. Even a modest emergency fund can help you avoid lasting consequences when an emergency or opportunity arises. 

Experts agree everyone should work towards an emergency fund, but a savings safety net can be especially impactful if you fall into one or more of these categories: 

• You have family or others who depend on you financially.
• Job security is an issue for you (if you’re self-employed or do contract work, for example).
• You want to start investing and build wealth. 
• You’re working towards becoming debt-free or financially independent.

“You should be saving for emergencies, not just because we told you to, but because it’s very stressful living paycheck to paycheck,” Red says. “Having that cushion can remove a lot of anxiety that surrounds your daily life.”

Where to keep your emergency fund

The best place to keep your emergency fund is in a secure account that you can access quickly should you need to. Many experts recommend high-yield savings accounts because they’re both easy to access and secure, and can help you earn a little extra on your balance. Some of the best high-yield savings accounts offer annual percentage rates over 5%. 

Savings accounts are one of the safest places to keep your money, as long as your bank or credit union is insured by the Federal Deposit Insurance Corp. or the National Credit Union Administration. These accounts are federally insured for up to $250,000 per person, per account.

“I love a high-yield savings account because they do take a little bit more effort to pull those funds out,” Torres says. If your savings account is at a different bank than your checking account, accessing your money can be challenging. Some online banks require you to connect your savings account to your checking account to access your funds. And some banks might limit the number of transfers you can make each month.

But remember, your emergency fund is the foundation upon which you build wealth. It’s not how you build wealth. “Don’t look at them like wealth-building accounts. People will say, ‘Well, I’m not going to make any money on that,’” Christensen says. “That’s not the point.” 

While you might earn more money in interest with a long-term investment fund, like a certificate of deposit, some CDs tie up your funds for years and penalize you if you withdraw your funds early. Instead, opt for a savings account with easy access to your funds.

Is it better to invest my emergency fund?

In a situation where you need immediate cash, you’ll want to have that cash safely parked in a savings account, available to draw from at a moment’s notice -- not invested in the stock market where it might lose value at any time.

“Emergencies typically tend to happen when the economy’s bad,” Saavedra says. “And when the economy’s bad, the stock market is not doing great. I think a high-yield savings account is a great option, but don’t think about your emergency fund as something you need to grow. Because, over time, it’s not going to matter relative to the size of your retirement fund. Just park it somewhere where it’s easy to access. Not too easy, but so that it’s cashable.” 

Building long-term wealth doesn’t happen overnight, nor can it happen solely through investing. An emergency fund can help you lay the groundwork for growing your wealth over time.

“If you’re building a skinny tall tower, it’s going to tip over at the slightest breeze because you don’t have the foundation of paying off your debt and establishing an emergency fund,” says Schneider.

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Editors’ note: An earlier version of this article was assisted by an AI engine. This version has been substantially updated by a staff writer.

This article also includes some material that was previously published on NextAdvisor, a CNET Money sister site that was also owned by Red Ventures and which has merged with CNET Money. It has been edited and updated by CNET Money editors.