How Much Should You Keep in an Emergency Fund
Don’t be caught off guard when a disaster hits.
Financial emergencies could pop up at any time without warning. When they do, they may take a serious toll on your savings account balance if you’re not prepared. While rebuilding your savings is possible, it’s far better to be prepared for emergencies before they happen. Building an emergency fund may help you do just that.
Emergency funds may help you cover unexpected expenses or provide you with money for essential costs if you temporarily lose your income.
The amount you save depends on your situation, income, lifestyle, and needs.
Having between three and six months of living expenses is a good goal for most people to aim for, but saving any amount could still help reduce your financial stress during periods of uncertainty.
Emergency Fund Overview
Think of your emergency fund as a financial cushion that may help you get through times of financial uncertainty. It’s money you use to pay for unexpected expenses like car repairs or medical bills and or to help pay for essential expenses, like housing, insurance, and food, if you lose your job.
The fund isn’t meant to replace your normal savings, instead it’s a specific type of savings that you earmark for emergencies, giving you cash on hand that may help you handle the unexpected.
How Much Should You Save in Your Emergency Fund?
Did you know that only 48% of American adults believe they have enough saved up to cover emergency expenses? And many of those individuals don’t have enough saved up to cover three months of living expenses if they were unexpectedly laid off or lost their jobs.
Without emergency savings in place, you may end up reaching for your credit card just to cover the essentials. And if you carry a balance on that card, you risk going into debt, racking up high interest charges, and possibly hurting your credit score.
While any amount of emergency savings may help you achieve and maintain financial wellness, the more you save, the better. So, how much should you have saved up? It depends on your personal needs and your situation. Let’s take a closer look at how to decide your ideal emergency savings target.
Determine Your Emergency Savings Target
Every person is unique and the amount of money they need to set aside depends on the costs they have, the number of dependents they have, and their income. But there are a few techniques you could use to figure out how much you want to save.
Pick the Right Strategy
There are several savings strategies you could use to create your ideal goal. These include setting your goal based on your average expenses, setting a goal based on your income, or setting goals based on the emergency type. There’s no right or wrong goal-setting method, but one may work better for you than another.
Say you’re worried about replacing your income if you were suddenly laid off. You may want to set your savings goal based on a percentage of your income to help you cover your expenses without forcing you to change your lifestyle until you find a new job.
If you’re worried about a specific emergency, consider which emergencies are most likely to happen in your area. For example, say you live in a flood-prone area and don’t have flood insurance, you want to save enough to help cover the cost of repairs. Find estimates for most major emergencies online to help you figure out how much you should save.
If you want to set your goal based on your expenses, total up your essential costs for the month, like include housing, food, healthcare, utilities, transportation, and minimum debt payments.¹
Decide How Long You Want Your Savings to Last
Once you know the type of goal you want to set and have a rough idea of how much you want to save, you need to decide how long you want those savings to last. Most finance professionals recommend saving three to six months’ worth of living expenses in your emergency fund. But that doesn’t mean saving more isn’t a good idea, especially if you’re concerned about the following:
Living through a recession
Losing your job because layoffs are common in your industry
Not having a steady income
Just wanting to have more funds on hand
Ultimately, it’s up to you to determine how much you want to save, whether that’s just a few months or more than a year.²
Using and Rebuilding Your Emergency Fund
Remember, your emergency savings are there to help you during times of financial strain. If you’re experiencing an emergency, use your savings to help you cover your expenses, even if you haven’t hit your goal.³ You could always rebuild your savings once the emergency passes. Just revisit your budget.
Consider reallocating funds that you were planning on saving toward another goal like a vacation and put them toward rebuilding your emergency fund. Keep contributing until you reach your goal. Once you rebuild your emergency savings, you’re able to start saving for those more fun items again.
Where to Keep Your Emergency Fund
Though you could keep your emergency fund in your normal savings account, doing so may make it difficult to track your progress and separate your emergency funds from your general savings. This may increase the temptation to use the money you’d like to set aside for emergencies to pay for other things.
Instead, consider opening a dedicated savings account for your emergency fund. Look for an account with competitive rates and compounding interest. These rates are represented as Annual Percentage Yield (APY) which tells you how much your savings earn over the course of the compounding period. With compounding interest, you have the opportunity to earn interest on the money you have in your account as well as the interest that your money already accrued. This could help your savings grow faster.
As you start shopping for a savings account, do your due diligence. Make sure the financial institution you’re opening an account with is either FDIC insured or NCUA insured as this helps protect your money up to the established limits of $250,000 per depositor, per account type, per institution.
Establishing an emergency fund is a great way to prepare yourself and your finances for life’s unexpected events. Any amount of savings may help you avoid going into debt during an emergency. But the best way to maximize your savings is to choose an account that earns competitive rates and could help you grow your money on autopilot. Check our guide to learn how to choose a great savings account.