How do I build an emergency fund?

If the coronavirus pandemic has taught us anything, it’s the importance of preparing for the unexpected. Having an emergency fund ensures that you have a financial cushion in times of need — like a job loss, car repair, or medical expense — without having to rely on credit cards or other high-interest loans.

Nearly 25% of Americans have no emergency savings and 16% have taken on more debt since the start of the pandemic. However, by regularly setting aside extra money — even a small amount — you’ll be able to recover more quickly should unexpected expenses or events happen.

How do I build an emergency fund?

There are several strategies you can use to quickly start building your emergency fund. A few include:

1. Open a high-yield savings account
2. Set up automatic savings
3. Create a budget
4. Save your tax refund
5. Assess and adjust

1. Open a high-yield savings account

A high-yield savings account generally pays 20 to 25 times the national average — which is 0.04% according to FDIC — of a standard savings account. This allows your money to grow much more quickly, leading to significant savings. The higher the annual percentage yield (APY) for that account, the faster you'll increase your savings.

These rates are variable and can change over time in accordance with the Federal Reserve making adjustments to interest rates. However, no matter the APY of a high-yield savings account, it will outearn a traditional savings account.

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2. Set up automatic savings

Set a monthly savings goal and automatically set that money aside every month. If your employer offers direct deposit, you can divide your paycheck and automatically deposit your emergency fund monthly savings into a separate account. This will get you into the habit of saving without giving it a second thought.

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3. Create a budget

When you know what’s coming in and what’s going out, you can cut expenses where possible and put that extra money toward your emergency fund. The average U.S. household spends almost $400 per month on basic utilities and, according to the U.S. Department of Agriculture, the average annual food-at-home prices were 3.5% higher in 2020 than in 2019 — 75% above average.

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4. Save your tax refund

If you’re expecting a tax refund, you can give your emergency fund a big boost once a year. When you’re filing your taxes, you can even have your refund directly deposited into your emergency fund savings account. On the other hand, you can adjust your W-4 tax form so that you have less money withheld from your paychecks to put toward your emergency fund.

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5. Assess and adjust

Make sure you periodically assess what’s in your emergency fund savings account and adjust when necessary. If you’ve recently withdrawn cash from your emergency fund, try directing more money into your account. Have you reached your financial goal? Consider investing those additional funds.

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How much money should you have in an emergency fund?

A good rule of thumb is to have between three and six months’ worth of living expenses saved in your emergency fund. Living expenses are what you need to pay each month. This can be your monthly mortgage or rent payment, utilities, phone bill, internet costs, insurance, transportation, food, and other debt payments.

The amount you save also depends on the stability of your income and whether anyone in your household has a chronic medical condition.

In a two-income household, a three-month emergency fund should be fine. If your household only has one income, you’re self-employed, you earn a straight commission, or if someone has a chronic illness, then six months’ worth of living expenses in your emergency fund is more ideal.

If you do decide to open a high-yield savings account, be aware that some accounts may require a minimum balance or a minimum opening deposit and some may have withdrawal fees. Interest rates are also variable, so while a bank may advertise a high APY when you apply, it typically doesn’t last.

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