How to Start & Build Up Your Emergency Fund in Savings

emergency red arrowFive days before Christmas last year, the downstairs area of my house flooded with groundwater. While the experience wasn’t fun, we were fortunate in that it wasn’t a budget disaster.

Many of our neighbors asked us how we were we able to handle the $2,300 in costs that came with damages associated with the flood.

The answer: our emergency fund.

What Is an Emergency Fund?

One of the central tenets to good financial planning is preparing for the future, whatever it may bring. Therefore, an essential component of a solid financial plan is an emergency fund.

An emergency fund is designed to cover a financial shortfall when an unexpected expense crops up. Your emergency fund can serve as a place to get the money you need when you find yourself short. Because it must be reliable, it needs to hold guaranteed investments. In other words, savings accounts are good for emergency funds, while stocks are bad.

An emergency fund, by nature, also needs to hold liquid or otherwise short-term, accessible investments. Ideally, you won’t need to use the money in your emergency fund, and you will maintain it for the long-term. However, this creates an interesting conundrum: a long-term account holding short-term, low-interest bearing investments.

To get around this issue and enhance my return on investment, I like to divide emergency funds into two main categories:

  1. Your short-term emergency fund is your go-to place when you have an immediate emergency. It should be in an accessible account, which will probably bear little interest. The most important consideration is accessibility. You’ll want a debit card attached to this account and check-writing privileges as well. The purpose of your short-term emergency fund is for smaller emergencies, such as car repairs or replacing a major appliance that has broken. It can also be used as a bridge to get you through the few days until you can access your long-term emergency funds in case of a more extreme situation.
  2. long-term emergency fund allows you to save for large-scale emergencies, such as job loss or a major natural disaster like an earthquake or fire, and earn a slightly higher level of interest. Accessibility is still important here, but it’s okay to choose investments that take a few days to liquidate – as long as you have a short-term emergency fund to cover you in the interim.

When you have an emergency fund, you have peace of mind. Your money is on guard, so to speak, just waiting to be called into action. You don’t have to scramble to come up with money you need and you don’t have to turn to credit cards. Even if your emergency fund isn’t big enough to handle everything, it can still help reduce the amount of money you must look for from friends and family, or credit cards.

What Makes for an Emergency?

It is important to realize that an emergency fund isn’t a slush fund for large entertainment and leisure purposes. A new big screen TV doesn’t qualify as an emergency, even if your old TV breaks down.

In order to ensure that your emergency fund is there when you need it, you need to be able to identify a true emergency. A true emergency is a situation that requires some sort of immediate action, and that can affect your long-term well-being or impact the viability of an important asset (such as your home).

Some situations that constitute true emergencies might include:

  • A large deductible or co-pay on a health emergency. You can save money on taxes related to healthcare expenses and put less strain on your emergency fund if you consider using a HSA with a high deductible health plan.
  • The need to travel or finance other arrangements as a result of a family emergency, such as a death in the family.
  • Major unexpected car repairs. This can include paying your deductible for damages caused by a car accident or paying for a new engine. Routine car maintenance, however, should be scheduled into your monthly budget. You could even follow these DIY car maintenance tips and save money.
  • The failure of a major appliance. If your furnace suddenly stops working or if your big freezer breaks, you may need to pay for a replacement quickly. Keep in mind the best times of the year to buy large appliances.
  • Large and unexpected home repairs or deductibles. If a tree branch falls on your home, you’ll at least have a deductible to pay as part of your homeowners insurance, and further problems could arise. Home repairs are vital to address immediately since your home is often your biggest asset.
break in case of recession

How Big Should Your Emergency Fund Be?

Prior to the financial crisis of 2008, personal finance experts recommended that your emergency fund contain three months’ worth of expenses. Now, the new financial wisdom is to have at least six months’ worth of expenses saved up. Of course, building an emergency fund can be difficult during a trying economy. If you are trying to get out of debt, one approach is to first build up a $1,000 emergency fund, and then redirect your efforts toward eliminating your debt. Then, once you’re debt-free, continue to build your emergency fund further.

To figure exact dollar amounts, you need to determine what constitutes six months’ worth of expenses. Simply add up what you spend each month in your household budget categories and multiply by six. Or you can review the past six months of expenditures if you’ve been using personal finance software (e.g. or a debit or credit card that tracks expenses.

Make sure you include what you pay on your mortgage, utilities, car loans, insurance, groceries, and other essential expenditures. I like to include entertainment items and incidentals that crop up during the month as well. Also, account for bills or other expenses that only come due once or a few times per year. For example, I pay my auto insurance quarterly and get four new tires on my car once every year.

The amount of money you put in each of your short and long-term emergency funds will depend on what you can afford and what you’re comfortable with. For my needs, I keep about $2,000 in the short-term fund, while I aim to build up six months’ worth of expenses in my long-term fund.

Emergency Fund Essentials

As pointed out earlier, emergency fund investments need to be guaranteed or at least very low-risk. They also must be liquid and accessible.

1. Low/No Risk

Unfortunately, investments often realize a rate of return that is directly proportional to how much risk they carry. This is why you’ll need to be satisfied with low-interest bearing accounts in your emergency fund. Checking, savings, and money market accounts as well as bank CDs and even physical cash are good choices.

Just make sure your bank accounts or bank-guaranteed investments carry FDIC insurance. Treasury bills, notes, and bonds have traditionally been good choices for safe investments as well. But since the guarantee attached to government-issued instruments has come into question, these may be treated as a very low-risk investment option, but not ones that are necessarily guaranteed.

The same holds true for other highly rated bonds and bond funds. Such investments may constitute a portion of your long-term emergency fund, depending on how comfortable you are taking on risk.

2. Liquidity

This represents how quickly your assets can be converted to usable cash. A savings account, for example, is 100% liquid because it already is cash. Bonds, though, have to be sold before you can use them and you must wait for the cash settlement period to pass (one day for government issued securities, three days for all others).

In some cases, cash products can also be problematic. CDs, for example, come with penalties if you withdraw money early. Understand the penalties of CDs you are considering or already own, since they can and do differ. Like bonds, CDs should constitute a portion of your long-term emergency fund.

3. Accessibility

A couple of years ago, I needed immediate access to my cash, but it was in an online savings account and took three days to get. That wasn’t soon enough. Luckily, my parents had enough money in their emergency fund to tide me over until my emergency fund could be accessed.

This experience is one reason I decided to create a short-term and a long-term emergency fund. My short-term account can be accessed immediately. And for bigger issues, the short-term account has enough to hold me over while I wait for my long-term funds to come through.

Aside from keeping cash on hand, make sure you have a debit card and ideally check-writing privileges attached to your short-term emergency fund. That way, you can access money at any time in virtually any place.

broken white piggy bank

Allocating Money to Emergency Funds

Any investment you can’t access immediately – via a debit card, writing a check, or pulling money out of a safe – goes into your long-term emergency fund. I like to keep my larger, long-term emergency fund in a high-yield online savings account in order to get a slightly higher rate of return.

One strategy I use is to put a portion of my long-term fund in high-quality bonds. By doing so, I can achieve a better rate of return with minimal risk and can liquidate into cash within a few days should I run into a large emergency. I keep my smaller, short-term emergency fund at a local bank. The yield isn’t as high there, but I can access my money immediately.

Some people also create a CD ladder in their long-term fund. You can create a CD ladder by purchasing multiple CDs such that one expires every month, or every three months, or at any other interval of your choosing. In this way, you know when the money will become available and you will only lose the interest on one CD (as opposed to all of them) should you need to access this money. Moreover, a CD ladder allows you to access higher yields that only accompany long-term CDs. However, a CD ladder should only make up a portion of your long-term emergency fund so you can avoid any penalties associated with premature access.

Lastly, consider using a credit card for an emergency if you can’t access your emergency fund in time. However, do so only if you can use credit cards and rewards wisely by paying off the full balance before the due date.

Building Your Emergency Fund

One of the most discouraging aspects to building an emergency fund is the large amount of money you must contribute. For some people, a $5,000 emergency fund seems out of reach. The good news is that you don’t have to fund your emergency account all at once. You can build it up a little at a time. The most important thing is to get started and to remain consistent so that over time you can reach your emergency fund goal.

Here are some tips for effectively building your emergency fund:

  1. Break it down. Decide how much you want in your emergency fund and figure out how much you can put in each month. Then, simply determine how long it will take to reach your target based on your monthly contribution. Breaking it down this way can make saving for your emergency fund and other goals more manageable.
  2. Use wasted money. Some estimates indicate that each household wastes at least 10% of its income each month. Look for the money leaks in your budget, such as over-ordering at restaurants or leaving the lights on. Plug them, and then use that money to build up your emergency fund.
  3. Make it automatic. Schedule regular payments from your checking account to your emergency fund, using automatic bill payment plans. You might also be able to have a portion of your paycheck diverted to your emergency fund. This way you don’t have to remember to do it yourself every month.
  4. Pad your account with dividend earnings. Dividend stocks aren’t just for income investing; you can also use them to pad your emergency fund. Build a portfolio that includes dividend stocks, and deposit those dividends in your emergency fund. This isn’t the fastest way to fund your emergency account, though, so make sure you are doing other things as well.
  5. Use spare change. Have your entire family empty the change from their pockets, perhaps including their one and five dollar bills, into a jar at the end of each day. This works especially well if you use mostly cash. At the end of each month, take the money in the jar and add it to your emergency fund. Again, use this technique to supplement or boost your emergency fund, but don’t depend on it entirely to get you to your goal.
  6. Celebrate milestones. Obviously, you don’t want to splurge big, but when you reach a milestone, reward yourself with a small treat, such as a night at the movies or a new book. Keep track of your goals and mark special achievements. Even cooking a fun celebratory dinner at home can be a good way to reward and motivate yourself to keep going.

Final Word

An emergency fund can mean the difference between financial failure and financial success. Not only must you develop discipline to accumulate one, but an emergency fund will prepare you for unexpected setbacks and reduce your dependence on borrowing money, most likely at high interest rates.

Carefully examine your expenses and use the information to develop an emergency fund goal, see how much you can save each month, and identify unnecessary expenses, or wasted money. Make a plan to build up an emergency fund and decide how you want it allocated. Finally, use your emergency money wisely.

Do you have an emergency fund? What strategies did you use to build it up? What circumstances have forced you to access the funds in the account?

  • Nancy

    Sometimes the old-fashioned way – save, not spend – is best. We have always lived well under our means and have had no problems meeting emergency financial situations that crop up from time to time. I also lean toward having money to cover six months of expenses (or more) set aside. When was the last time all your monthly expenses went down?

  • Cat

    I’m going the Dave Ramsey way- $1000 in an emergency fund and everything else goes to debt.

  • Mike

    I keep mine in an ING savings account, and have opened an Orange Checking account so that I can get the money out quick with the debit card if need since the transfers are immediate within ING. Also, by opening an orange account I was able to get an account bonus.

  • Gina

    Last year my husbands car ‘died’ unexpectedly. Although we were not happy to purchase a car before we thought we would need to, we were able to buy another car with the cash that we had saved in our emergency fund–NO CAR PAYMENT!

    • Komrad

      Better yet, fix the car and not have to buy one!!

  • Eric Smith

    While Dave Ramsey’s recommendation of building up an emergency fund first is echoed by many, and is sound advice, I believe that his initial maximum of $1000 is too low. Take Gina’s example above, for instance. If she had only saved $1000, purchasing a replacement car – even a used one – would have been very difficult to impossible with only $1000.

    My initial Emergency fund goal is $5000, and I think I’ve got a good start; in less than 6 months, via cutting back on spending and selling a number of things (on eBay, Amazon and Craigslist), I have been able to save 50% of my goal. After I reach $5000, I will throttle back the money going to it and funnel that money towards debt (of which we have no CC debt, so we are lucky there). However, I won’t cut off my contributions to my E-Fund entirely. I will keep it on life support with a small, automatic contribution each month and let it build; the bigger the cushion, the softer the landing.

    Why $5000? In looking at the emergencies that might befall me and my family, I have found that $5000 would be the minimum to cover the most costly one – meaning our deductible from our health insurance; after that our health insurance would cover the rest. Or we could replace all of our most important appliances – furnace, water heater, refrigerator, etc. – or purchase a reliable used car if need be with $5000. Or it could also be used to cover 4 months of mortgage should one of us lose our job. To me, beyond the necessities – food, water, utilities, etc – health, shelter (including heat and hot water), and transportation are the most important items and should be the focus of the emergency fund. Everything else – cable, internet, TV, cell phone, etc, etc – can be dropped if needed.

    I would recommend looking at these main items and figuring what the minimum would be to cover the most expensive one and set your emergency fund initial target to that. Once you have reached your goal, continue to contribute to it with a small amount each month – thereby building a greater safety net – and a breath a sigh of relief knowing that the worst is covered.

    • Komrad

      $1000 is his initial minimum . After you get out of debt you increase it to 3-6 months expenses.

  • Susan

    I totally agree and feel confident that our emergency fund is there for us. However, I really struggle with that amount of money just sitting there earning minimal interest in our online savings account. I wish there were a better option that still makes the money accessible relatively quickly.

  • KristyT

    We had a month’s worth of expenses saved in an emergency fund; I, the only wage earner, lost my job in May and didn’t find another one until August. Our emergency fund allowed us to keep our home this summer. Unfortunately, now comes the struggle to replenish it… it’s only got $50 in it now.

  • r0berts

    My father drilled in an Emergency fund since I left home. I used to think he was over-cautious, but I have thanked him so many times since. Its a must for me now

  • Charissa

    You have to pay yourself first and adjust your cost of living accordingly. Do you really need a cell phone and a home phone? What about telecommuting one or two days a week to save on travel costs?

    There are ways that you can cut back without depriving yourself. My husband and I have experimented with every frugal tip that we have run across. In fact, I have so much knowledge now that I plan to write a book on the subject.

  • Melissa

    I do my emergency fund a little bit differently. I have $1000 in a savings account linked to my checking that earns interest at a pretty low rate. The rest of my emergency fund sits in my Roth IRA. I can withdraw my contributions at any time without penalty and the last time I withdrew money I had the check in my mailbox the next day…faster than a high interest savings account.

    I invest my emergency fund in my Roth for a couple reasons. First, I have better returns there. Second, it’s way too easy for me to “borrow” money from my EF if its easy to access. However, since I pay a nominal fee to invest my contributions, you better believe I’m not going to touch that money for anything shy of a real emergency.

    I realize that I can lose my EF in the stock market, but I always keep some of my investments in pretty low risk mutual funds. I didn’t lose every last cent in the last market downturn and doubt I ever will.

  • Lauren

    I have a question for all of you who have reached your initial emergency savings goal. How did it take you to reach your initial goal? I’m slowly approaching my initial goal of $1000 but I always feel like I should already be there. I chose the $1000 amount because it was still a bit of a stretch for me but it’s doable. Once I reach the $1000 goal, I’ll set another, higher goal.

  • Mayra Cedillo

    Do any of you know the difference between 403 (b) and the other account geared for educators?

  • Connie

    On the list for this year. As well as an energy audit (we live in ontario and the government pays us to make our house energy efficient.)

  • Mami2jcn

    We started working towards this goal in 2009 and we definitely have at least 3 months saved. I was under the impression that 6 months was a must, so it’s comforting to know we’re okay at 3 months.

    I second the recommendation another person made about an ING savings account. We also have a Roth IRA.

  • Linda

    I was really hesitant at first at the thought of having thousands of dollars sitting still in a savings account when I could otherwise be using it to invest- especially as my highest interest rate right now was 1.5% at ING. But after a few months of research (enough time to save up half of my emergency fund anyway), I was lucky enough to find a tax-free savings account offering 3% at a local bank.

  • Jennifer Phillips

    This is so hard to do! With all of the job losses and living week to week and not making it on that I really wish we had done more when we had the chance. I hope that my children will learn from our mistakes and do the right thing. I try to read to them from this and some other blogs the importance of savings. One seems to be getting it, the other I am worried about. Our emergency fund was depleted when I had to go in for 3 different surgeries all in a row, and it was right when the job shut down, out of work no insurance. We will make it back, but I can’t say enough how important this is and to pass on the importance.

    • Erik Folgate

      Thanks for sharing that story Jennifer! It’s definitely a testament to the importance of having cash on hand to pay for life’s emergencies.

  • Dale Wyrick

    The emergency fund is key. I find that you have to make it a priority and after using the fund. It is important to reevaluate your finances and rebuild that fund. This is hard because you may not be in a great situation but that is your pillow to catch you when you fall. Make it too thin and the fall will hurt.

  • Sean

    My emergency fund is a bit anemic right now, but I’m hoping to jump start it with a bonus that will hopefully come through. I figure if I can get it mostly funded then it doesn’t seem like such a giant task. Then I can breathe a bit and save for other “things”

  • Stephanie

    I think my problem is that I don’t know when to stop! I probably have way too much money in my emergency fund, money that could be used to pay down debt or perhaps focused towards a financial goal (wedding, down payment, etc.). I did start a separate down payment fund, but I still feel like I’m being silly putting so much away.

    At any rate, until I can convince myself that I have a good enough emergency fund, I’ll keep putting my automatic transfers there…and once I find a new plan, I’ll continue to automatically transfer the money to a new goal.

    • Rick

      Stephanie, putting money away is never silly. Look at it this way, only money that is actually saved can be considered wealth. There are many people who earn a very good living, but spend every penny (and then some). Although they may drive expensive cars and live in big houses, those people are not wealthy. As your savings grow, so does your wealth.

  • not given

    My emergency fund is going to buy things we know we will need soon. Keeping our prescriptions filled, pantry filled, gas tanks full. Until bankruptcy is finalized what else can I do? I can’t start an emergency fund in case the trustee can take it and leave me without enough cash to fill my prescriptions or buy groceries or pay utilities.

    I don’t know when I can start putting away money in a savings account for emergency purposes, or even to pay my next auto liability insurance or property tax bill.

  • Taz

    Our emergency fund IS easily accessible…as cash in the house. We recently had our hot water heater go out…but did not have to panic because we had to the cash to pay for it. No credit, no interest, no bills later. I want to build it up further but am also working on debt reduction at the same time.

  • Miranda Marquit

    Thanks, everyone, for stopping by and sharing your stories. Some of these are inspirational, for sure.

  • RandyMan

    A cash-only Emergency Fund should not be more than 6 mos of expenses. Here’s why … dividend yielding stocks (utils, tobacco, etc) earn from 4-9% and when that’s re-invested, it annualizes to 8-12% over a 10-20 years. And this only assumes a *flat* market, no cap gains. Thus, it works for a muddle-through bear market channel. If you’re out of a job, unemployment insurance can carry you, for a year or so, before you have to touch those 6 mos and if it really looks like you’ll never find work, you can cash out your stocks and then, go for re-training or re-location.

    • Miranda Marquit

      Great point! Cash won’t provide you the same earnings that other choices might give. A great idea to use other means as well; your six months can give you enough of a cushion to keep going, and you have sufficient time to sell other investments if needed.

  • Roberto

    “For example, I pay my auto insurance quarterly and get four new tires on my car once every year.”

    Who replaces their tires once a year?!

    • sam12587

      not me, I usually wait till one has or is close to a bald spot of some sort & then only do all four if my car has ABS.