App version: 0.1.0

Guide to Emergency Funds

Guide to Emergency Funds
Susan Guillory
Susan GuilloryUpdated January 24, 2023
Share this article:
Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Without any emergency savings, a large unexpected expense could set you back, and if it turns into debt, have a lasting negative impact on your financial health.If you’re currently living paycheck to paycheck, though, building a backup fund may not feel like a top priority, or even seem feasible. The good news is that you don’t need to create an emergency fund overnight. Even putting a small amount of money into savings each month can go a long way toward building some financial security.Read on to learn how an emergency fund works, how much you should have set aside in emergency savings, and how to start building a backup fund today, even if money is tight.

What Is an Emergency Fund?

An emergency fund is a stash of money that’s specifically set aside for unexpected expenses or financial emergencies. Examples include car or home repairs, a broken computer, medical expenses, or a loss of income. This money isn’t for buying clothes or going on vacation. It’s designed to be used only for that proverbial rainy day.Recommended: How Much Does the Average Person Have in Savings? 

Why is Having an Emergency Fund Important?

An emergency fund is an important part of every adult's life. Here are some of the many ways you can benefit from having one.
  • It can keep you out of debt. A backup stash of cash allows you to handle any unexpected bills without having to rely on credit cards or high-interest loans. This can be especially important if you already have debt, because it can help you avoid borrowing more and getting deeper in the hole.
  • It reduces financial stress. Knowing you have a financial buffer can relieve a lot of worry. Even if the “check engine” light turns out to be a real — and real expensive — problem, you know you can cover it and still buy food and pay the rent. 
  • It keeps you from spending everything you earn. When you set up an emergency savings fund (more on how to do that below), a small amount of your earnings will get whisked aside before you can spend it on something else — or even miss it. 
Recommended: How Much Cash Should You Keep at Home?

How Does an Emergency Fund Work?

It’s generally a good idea to keep an emergency fund in an account that earns interest but still allows easy access to your funds, such as a savings account or money market account at a traditional bank, online bank, or credit union. To make sure you don’t end up spending the money on something else, it can be a good idea to open a separate savings account earmarked for emergency savings. Once you set up an emergency savings account, you can gradually build your fund by adding a little bit of money to the account each month. 

Emergency Fund Uses

So what can you use emergency funds for? Really, anything that is an unplanned but essential expense. This might include:
  • Car repairs (bodywork, new transmission, new tires)
  • Health expenses (hospital visit, deductible, medicine)
  • Technology (replace your broken computer, laptop, phone)
  • Job loss (to cover expenses until you work again)
  • Home repair (broken hot water heater, roof repair)
  • Essential travel
  • Pet care
What emergency funds are NOT for:
  • Big clothing sale
  • Last-minute trip to the beach
  • Massages or haircuts
It can require discipline to not touch your savings, especially if you don’t have extra money for fun things like shopping or vacations. But in the long run, when an emergency pops up, you’ll be very glad you had the funds.

Average Amount to Save in an Emergency Fund

How much of an emergency fund should you have? There’s no set amount but one general rule of thumb is to have enough money put aside to cover at least three to six month’s worth of living expenses. The idea is that, should you lose your job, you would have enough cash to pay for the necessities until you get a new one. If you freelance or your job would be hard to replace, you might need more than six months of expenses set aside.To get a sense of how much that would be for you, you’ll want add up your fixed monthly expenses, including:
  • Mortgage or rent
  • Car payment 
  • Gas/transportation costs
  • Insurance payments
  • Groceries
  • Utilities (internet, electricity, gas, phone)
  • Childcare
If the total you come up with seems intimidating, keep in mind that an emergency fund of any size is better than none at all. Even a reserve of $500 can get you out of many jams. It’s okay if your fund starts out small. It will build over time.Recommended: What to Know About Loan Protection Insurance Before Purchasing a Policy

Common Places to Put Your Emergency Fund Savings

Because emergencies, by definition, strike with no warning, you want to be able to access your emergency funds quickly. So you don’t want your rainy day money tied up in long-term investments. On the other hand, you don’t want the money to be too accessible. If it’s sitting in your checking account, you will likely end up spending the money on other things.One good solution is a savings account. This type of account pays interest, allows you to easily access your cash when you need it, and keep your money safe. Typically, savings accounts are federally insured up to $250,000 per account holder, so you can’t lose your money even if the bank were to go belly up. While the funds in a savings account are liquid, they are generally less accessible than the funds in a checking account. Checks can’t be written against them, and you’re often limited to six withdrawals or transfers per month. If you exceed the bank’s transaction limit, you’ll likely be charged a fee.Two types of savings accounts that can work well for an emergency fund include:
  • A high-yield savings account These accounts are typically available at online banks and offer the same features and protections as traditional savings accounts. The difference is that they generally offer a significantly higher annual percentage yield (APY) than the average interest on a savings account.
  • A money market account A money market account offers the features of a regular savings account along with some of the conveniences of a checking account, such as checks and a debit card. APYs are generally higher than a standard savings account, but you typically need to maintain a higher monthly minimum balance (which could be an advantage for an emergency fund). You can find money market accounts at credit unions and traditional and online banks.
To find the best rate for your emergency fund, you’ll want to compare savings accounts by looking at APYs rather than interest rates. An APY tells you how much your money will earn in a year and includes compounding (when the interest you earn also earns interest). Interest may be compounded on a daily, monthly, or yearly basis. By comparing APYs, you’ll be able to compare savings accounts apples to apples.Recommended: Savings Account vs Brokerage Account 

Building an Emergency Fund

If money’s already tight, how can you put aside funds for a rainy day? Here are a few tips to get you started.

Set a Savings Goal 

You can tally up how much you want to eventually have in your emergency fund by calculating your necessary monthly expenses and multiplying that number by three, four, or, ideally, six. Some financial experts actually advise having a full year’s worth of expenses set aside for the unexpected.

Start Small 

Your savings goal may look intimidating, but you don't have to reach it overnight. Even putting aside $25 a month in your emergency fund can add up to $600 in two years, not including the interest you will accumulate on that money.

Automate Your Savings

Once you set up a savings account for your emergency fund, you may want to also set up an automatic transfer from your checking account into that account for a certain amount on the same day each month (perhaps on the day you get paid). That way, you don’t have to remember to make transfers. 

Take Advantages of Windfalls

If you get an unexpected (or expected) lump sum of cash, say a bonus at work, a cash gift, or a tax refund, consider putting that money directly into your emergency savings fund. This will give your fund a big boost and help you reach your savings goal faster.

Use Apps to Your Advantage

There are a number of apps that can make savings seem like less of a hassle. A “round-up” app, for example, will round up each debit card transaction you make and put the change in your savings account. This can be particularly helpful if saving is a struggle for you — you won’t miss a few cents, and it can add up surprisingly quickly.

The Takeaway

Accidents happen. Refrigerators go on the fritz. Car brakes wear out. Having an emergency fund helps ensure you can cover any unexpected costs that come up without having to rely on credit cards or help from friends and family. No matter how much money you make, it can be a good idea to put some money aside each month into a savings account earmarked for emergencies that earns a competitive interest rate. If you’re interested in finding the best rate for your rainy day fund, Lantern by SoFi can help. With our online banking marketplace, it’s easy to compare high-yield savings accounts based on APY, fees, and balance minimums.Lantern can help you compare online savings accounts and find today’s best rate.

Frequently Asked Questions

What is the average amount to save in an emergency fund?
Do you really need an emergency fund?
Where should you keep your emergency fund?
Photo credit: iStock/Sezeryadigar

About the Author

Susan Guillory

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
Share this article: