How to Start an Emergency Fund

Emergency funds play a critical role in any strong financial plan. However, you may wonder about the best way to start an emergency fund and how much money you should contribute to your emergency fund account.

The easy answer is that most people choose to save enough money to cover three to six months of expenses in a high-yield savings account or other low-risk option with high liquidity.

However, there are a few nuances and additional strategies you should know about to help build a stronger safety net and protect your future.

In this article, we’ll cover a few money-saving strategies and provide some simple tips for starting a new emergency fund.

What is an emergency fund?

An emergency fund is an amount of money you set aside to soften the impact an emergency might have on your finances.

Specifically, having an emergency fund available can improve your financial security by providing a safety net that catches unexpected expenses before they can upset your finances—and your life.

Emergency funds are especially helpful when it comes to important and immediate expenses.

For example, you’ll still need to pay for housing, food and other necessities if you lose your job. These payments are important (because you need them to live) and immediate (because you can’t put them off until you save up money in a few months).

Compare this example to a situation where your favorite store has a huge sale. While the situation is immediate (since the sale would end soon), it’s not critical to your daily life and thus wouldn’t be as important.

Similarly, expenses that are important but not immediate—such as contributing to a retirement account or saving up for a routine doctor’s visit—may not justify taking money out of your emergency fund.

How much money should I save up in my emergency fund?

The simple answer is that you should save as much in your emergency fund as you can afford. Even an emergency fund of a few hundred dollars can help soften the blow of an unexpected expense.

In most cases, financial professionals recommend saving up an emergency fund that can cover roughly three to six months of your household’s expenses.

However, the amount you should save in your specific situation will largely depend on your risk tolerance.

If you live alone and have minimal expenses, you might only need a small fund that covers three months of expenses.

On the other hand, families and individuals with mortgages and higher expenses might need to save enough money to cover six months of expenses or more.

In general, you should save enough money to make yourself feel safe if you lose your job or face another unexpected challenge or surprise expense. Outside of that, your final emergency fund savings goal is ultimately up to you.

Where should I keep my emergency fund?

You should generally save your emergency fund in an account that’s both low-risk and liquid in nature.

Remember, the whole point of an emergency fund is to have quick access to your funds in the event of a financial emergency.

For this reason, riskier options such as investment accounts loaded with stocks typically aren’t recommended since drops in the broader market could wipe out parts of your savings.

Liquid options such as IRAs are also not ideal because you may be penalized for taking the money out early.

In general, this leaves four interest-bearing emergency fund account options worth considering:

• Money Market Funds — A money market fund is a mutual fund that invests in low-risk, short-term debt and cash equivalents such as government bonds and CDs. While these funds generally don’t grow in value, they can generate income through dividends to help grow your emergency fund over time while keeping your funds liquid.
• High-Yield Savings Accounts — High-yield savings accounts are another option for keeping your funds safe while still allowing them to grow. Savings accounts can’t lose value (except through inflation), making them one of the safest options for saving money over time. However, they also typically generate less interest than other account types, meaning the value of your funds may decay over time due to inflation.
• Government Bonds — Government-issued bonds such as I-bonds are an increasingly common strategy to save money for emergencies in a way that also maximizes growth and offsets inflation. While you should never tie up all your funds in government bonds, they can be an effective way to save a portion of your emergency fund for the future. Specifically, you can cash government bonds in after one year for a minor penalty or after five years for no penalty. Since these bonds generally have a return of close to 7% annually, they’re a commonly used solution for outpacing inflation while keeping your funds liquid (after the one-year waiting period).
• Certificates of Deposit (CDs) — CDs are a financial tool used by individuals who want to grow their money over time without taking on the level of risk seen in money market and other account types. As with government bonds, you can put your money into a CD to take advantage of a higher interest rate. In exchange, you must keep your money in the CD for a set period, usually between a few months to a few years.

How to start saving for your emergency fund

There’s no “right” way to start an emergency fund. Instead, you should contribute as much money as possible until you feel protected from unexpected expenses.

We’ll outline a few strategies to help you save below, but the key thing to remember is that your savings plan should work for you.

No matter which strategy you choose, the most important factor in growing your emergency fund is to ensure more money is going into the account than out of it.

Save up at least one month of expenses immediately

To begin, you should choose a small savings goal to help you jumpstart your account.

Start by calculating how much money you spend in the average month on “needs” such as housing, groceries, insurance and transportation. This calculation will be your first savings goal.

For the next several months, deposit any extra money into the account until you reach your savings goal.

A few common strategies for funding your emergency fund include:

• Depositing a small amount every month to build a habit of saving regularly.
• Placing an end of the year tax refund—or any other unexpected income—immediately into your emergency fund for a rainy day.
• Cutting one or two things from your monthly budget (such as a subscription payment, one meal out per month or other regular expense) and diverting this money into your emergency fund during the initial funding period.
• Selling items you no longer need or starting a small side hustle to gain extra income.
• Saving up enough money to cover a month’s worth of expenses should be your top financial priority during this period.

Once you’ve saved up enough to have a small safety net, you can take your foot off the gas slightly and fall into a pattern of regularly making smaller contributions until you reach an amount that can cover three to six months of expenses.

Know when to stop saving

Emergency funds are one of the few cases where you can save too much money.

Specifically, the primary benefit of an emergency fund is that it provides quick and easy access to your funds in the event you have to pay for an unexpected expense.

However, because of the nature of these accounts, you should always save your money in a place that’s both low-risk and easy to access quickly.

While there’s a low chance of losing money in these accounts, there’s also little upside to keeping a large amount of money in a place where it can’t grow over time.

For this reason, it’s important to strike a balance between how much money you need in your emergency fund to feel comfortable and how much money you’d prefer to use elsewhere to invest or pay off your debts.

Depending on your risk tolerance, you may want to save more or less money in your emergency fund because of the potential for that money to grow faster elsewhere.

Make your emergency fund a part of your broader financial plan

Emergency funds solve one specific and common financial problem: how do you save enough money to pay for unexpected expenses?

While an emergency fund is a valuable part of any strong financial plan, it’s also generally not the best solution to other common financial needs. You should make your emergency fund a small but important part of your broader saving and investing strategy.

Generally, this means saving up around three to six months’ worth of expenses in a high-yield savings account, a money market account or some other solution with low risk and high liquidity.

No matter your strategy, the key thing to remember is that any amount of emergency savings is better than no emergency savings.

Keeping a few hundred dollars in a savings account for a rainy day is a great way to build a safety net for your future.

If you have any questions about the options available for saving and growing your emergency fund—or if you need advice on how you should start saving—give us a call at 800-236-8866, schedule an appointment or visit us at any of our Associated Bank locations.

We’d be happy to walk you through the basics of building a financial safety net and protecting yourself from unexpected expenses in the future.