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Life has a way of throwing expensive surprises when you least expect them. A flat tire, a broken appliance, an unexpected medical bill, or a sudden job loss can quickly turn a normal month into a financial crisis. That’s where an emergency fund comes in.
A savings account for financial emergencies allows you to pay your rent or mortgage, put gas in your car, or replace a failed appliance without going into debt if you unexpectedly lose income. Even an emergency fund as small as $250 can lessen the chance of eviction or inability to pay an important bill for American families, according to a study by the Urban Institute.
In other words, by setting aside cash specifically for emergencies, you give yourself a safety net that protects your budget, your credit, and your peace of mind when the unexpected happens.
An emergency savings fund is money you set aside in an account so you don’t have to rely on credit cards, loans, or tap long-term savings when life throws you a financial curveball.
Emergency funds are meant for surprise expenses such as:
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Job loss or reduced income
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Medical or dental bills
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Car repairs or home maintenance
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Emergency travel
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Unexpected insurance deductibles
On the other hand, an emergency is not for planned expenses such as vacations, holidays, or routine bills. Additionally, an emergency fund is not the same as your regular savings or retirement accounts. The point of an emergency fund is to help you avoid dipping into your savings or taking on high-interest debt by using a credit card or loan to pay for these expenses.
Read more: These are the 2 times you should tap your emergency fund vs. savings account
A good rule of thumb is to keep enough money in your emergency savings fund to cover three to six months’ worth of essential living expenses, including:
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Housing
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Utilities
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Food
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School tuition
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Cell phone and internet
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Transportation
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Insurance
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Childcare
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Debt payments
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Taxes
For example, if your monthly expenses are $3,000, aim to keep at least $9,000 to $18,000 in your emergency fund.
However, if you have a job with fluctuating or unpredictable income, you might want to target nine to 12 months’ worth of expenses as an extra buffer.
Read more: How much money should I have in an emergency savings account?
Keeping your emergency fund separate from your everyday checking and savings accounts is a smart move. Ideally, the account should earn interest while still allowing you to access your money quickly when an emergency arises. Here are a few account types worth considering:
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Traditional savings account: Many savings accounts at brick-and-mortar banks offer relatively low interest rates, but they’re often very convenient. You can usually withdraw funds easily at an ATM or by visiting a local branch.
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High-yield savings account: These accounts work much like traditional savings accounts but typically earn 10 times more interest or more. The trade-off is accessibility: most high-yield savings accounts are offered by online banks, so you won’t have access to a physical branch. Deposits and withdrawals often require transfers from another account, which can take one to five business days. That said, many online banks offer ATM access and mobile app features that make managing your money easier.
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Money market account: Money market accounts combine the features of both savings and checking accounts and often come with a debit card and/or check-writing privileges. Top-yielding money market accounts can offer interest rates comparable to high-yield savings accounts. However, they may require a higher minimum balance to avoid monthly fees.
Read more: The 4 best (and worst) places to keep your emergency fund
To start your emergency savings fund, take some time to figure out what you can contribute to an account each week or pay period. Don’t worry if it looks like it will take you a long time to reach your goal of saving enough to cover three to six months’ worth of expenses. Even small — but consistent — contributions will put you on track to build your fund.
One good option is to set up an automatic, recurring transfer from a separate checking or savings account. Another is to direct deposit a portion of your paycheck into your emergency fund. This makes saving automatic and can reduce the temptation to spend your money elsewhere.
And just as an emergency fund is ideal for paying unexpected expenses, it’s also a great place to deposit unexpected income. If you receive a higher-than-anticipated bonus at work or a tax refund, put some or all of that money into your emergency fund to help it grow.