How to build an emergency fund in 6 steps — and why you should

Let’s get real: Life’s expensive. There’s rent or your mortgage, gas, groceries, and the big one — insurance, with prices rising by the day. Imagine if, on top of all that, your car breaks down, or a fun day of kayaking turns into “There goes my phone.”

Time to call on that emergency fund. Don’t have one? Don’t worry. We’re here with the 411 on emergency savings accounts, including how to start and grow your own.

What is an emergency fund? 

An emergency fund is money you’ve saved for unplanned expenses or financial emergencies. It’s your backup plan, ready to step in when life throws you something you didn’t see coming.

“It’s your family's financial safety net — money set aside to handle life's surprises without going into debt or derailing your budget,” says Frances Rahaim, Ph.D., president of HUG Your Money, Inc.

While hiding money under your mattress might be tempting, it’s safer to use the bank, as funds are FDIC-insured. This means the Federal Deposit Insurance Corporation will reimburse you, in the rare case your bank fails.

We recommend keeping your emergency stash in a dedicated savings account, separate from your regular savings or checking account. That way, you’ll know exactly how much money is available for an emergency versus a specific savings goal. 

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Bonus tip: Give the account a name like “For Safekeeping” or “Unexpected Expenses” as a reminder not to dip into it. 

6 steps to building your emergency fund

Now that you’ve crunched the numbers, let’s learn how to build and grow your emergency fund.

1. Open a high-interest account 

One of the best ways to build your emergency fund is to put it in a high-yield savings account, where you’ll earn compound interest on your emergency savings. In other words, the bank will pay you to keep your cash there. 

How much? It depends on your deposit amount and the account’s APY (Annual Percentage Yield). For example, let’s say you make a one-time deposit of $1,000 at 3% APY. That deposit would be worth $1,020 after 1 year, $1,040 after 2 years, etc. The higher the APY, the more money you’ll earn. 

Your other option for storing emergency funds is a money market account, also through the bank. Just like a high-yield savings account, money market funds earn interest. One key difference: Many require a minimum balance to start an account. So, depending on how much money you have saved, you might not be able to open one with a high-interest rate.

2. Track your savings progress

When you set the intention to check your savings regularly, you’re more likely to reach your emergency savings goal, whether it’s a few dollars a month or hundreds. You can set up automatic account balance notifications to help keep you in the loop.

3. Manage your cash flow 

Cash flow is your income minus expenses and spending over a specific time period. You can find opportunities to adjust your spending and saving by tracking your cash flow. For example, you might notice more money available during specific weeks. That’s the perfect time to move some of it into your emergency savings fund.

When calculating cash flow, consider doing the math for three months’ worth of income and expenses, then averaging that number for accuracy. This is especially important if you are a freelancer or working a gig where your income goes up and down.

4. Automate your savings

If you’re a fan of ‘set it and forget it,’ you’ll love recurring transfers. Most banks let you automatically transfer money from your checking account to your savings. You get to decide how much money goes into your emergency savings account and when. If your income changes, you can always adjust the settings for recurring transfers. 

5. Split your paycheck 

Another way to automate savings and avoid overspending is to divide your paycheck between your checking and emergency savings accounts. It’s easy — just ask your employer for a direct deposit form. You’ll have the option to fill in either the percentage of pay you want deposited into each of your bank accounts or a specific dollar amount. 

6. Use windfalls wisely

What’s the most wonderful time of the year? Winter holidays are high on the list, but it’s tax-refund season for many. You can use it as an opportunity to deposit some of your refund into your emergency savings account. The same goes for any money you find in your birthday card. “Another strategy that's worked great for my clients: bank any ‘extra’ money like tax refunds, birthday cash, or overtime pay, says Andrew Lokenauth, family finance expert and founder of Be Fluent In Finance. 

How much should you save for an emergency fund?

If you’re asking yourself: “How much should I have in my emergency fund?” The short answer is: It depends on your situation. “I ​​typically suggest 6 months of expenses as the sweet spot. But here's the thing — it depends on your job stability and family situation," says Lokenauth. "I've got self-employed clients who I advise to keep 12 months saved because their income is less predictable. For dual-income families with stable jobs, 3 months might be enough.”

To calculate an emergency fund goal for your situation, add up how much (on average) it costs per month for the following living expenses:

• Monthly rent or mortgage payment 

• Utilities like gas, electricity, water, and trash

• Telecom, including phone, cable, streaming services, and Internet 

• Insurance for car, health, and home

• Transportation costs, including your car premium, gas, and public transit

• Debt payments for credit cards or loans (but not mortgages)

• Groceries

Add those numbers up, then multiply by three (as in three months), and that’s how much money you’ll want to set aside for your emergency fund. If the amount isn’t doable right now, it’s okay. Start small. Even if it’s just $5, you’ll do yourself a huge favor. Remember that the ultimate goal is to work your way up to six months’ worth of expenses. 

Why it’s a good idea to have an emergency fund

In short, life happens. Inflation happens. Recessions, job loss, and unplanned expenses happen. You could be looking at thousands of dollars if you get hit with a vet or medical bill. The same goes for unexpected home repairs. Insurance doesn’t always cover it. Wouldn’t it be nice to be prepared?

An emergency fund is how you prepare. It gives you the financial security to handle those emergencies, easing stress. With a dedicated emergency savings account, you don’t have to turn to credit cards, loans, or your retirement fund for money, helping you avoid a big setback — like debt. 

Dr. Rahaim emphasizes the importance of preparation. “It’s not about if an emergency happens — it’s when. Having savings ready means you can handle life’s bumps with a lot less stress and a lot more confidence,” she says.

Emergency savings: Check. Now, keep it going.

Now that you know how to start an emergency fund, you’re one step closer to financial security. Ready for more money management tips and tricks? Here are 13 money lessons our parents taught us. Thanks, Mom and Dad!

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