What is an emergency fund?

An emergency fund is money in a bank account that’s set aside for unplanned expenses, such as medical bills or automobile or home repairs. An emergency fund can also help you weather a loss of income from job loss or extended illness. Using funds earmarked for unexpected bills can reduce the need and the costs associated with high-interest credit cards or personal loans to pay them.

Why an emergency fund is so important

An emergency fund is an essential part of a solid financial plan. It can help you pay unexpected expenses, and avoid taking on more debt from high-interest credit cards or loans.

Having an emergency fund can provide peace of mind by assuring that you have money when a sudden expense happens. A June 2022 Bankrate survey about emergency savings found that 58 percent of Americans are concerned about the amount they have in emergency savings. Meanwhile, another Bankrate survey from January showed that only four in 10 Americans have enough emergency savings to cover an unplanned $1,000 expense.

The findings reaffirm the need for households to have a well-funded stash of cash and that it’s never too soon to start saving for an emergency.

“By nature, unplanned expenses are unexpected, so the sooner you’re prepared the better off you’ll be when the inevitable happens,” says Greg McBride, CFA, Bankrate chief financial analyst.

Without an emergency fund, your only options may be credit cards, personal loans or asking relatives or friends for money.

How much to save in your emergency fund

An emergency fund should cover three to six months’ worth of expenses, but saving that amount takes time. To help get you started, begin with small goals, such as saving $5 a day. Then work your way up to a reserve to cover several months’ worth of expenses.

Your savings goal will depend on your income and expenses. Focus on having enough to cover expenses, not on replacing your entire income.

Sole breadwinners, business owners or those with variable incomes should aim for nine to 12 months’ worth of expenses in an emergency fund.

Where to keep your emergency fund

The best place to keep your emergency fund is in a high-yield savings account, which offers easy access and pays a competitive yield. Look for banks and credit unions that insure deposits through the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA).

Online-only banks are good options for an emergency savings account because they typically offer higher yields and charge lower fees than brick-and-mortar banks. Fees can eat into your emergency fund balance, which makes comparing savings rates and account features key.

Also, there’s no need to stick with an account just because you’ve had it a while. Consumers keep their savings accounts for an average of nearly 17 years, according to a January 2022 Bankrate survey, but if the current account charges monthly fees or pays a subpar annual percentage yield (APY), it’s worth some inconvenience to find a new account that offers better terms.

7 easy steps to get your emergency fund started

1. Make a budget and see where you can start saving more money

To find ways to save, you first have to understand where and how you spend. Budgeting helps you distribute your income more efficiently and find ways to reduce or manage your spending. Bankrate’s Home Budget Calculator can help you to set a budget.

A budgeting app is another useful tool that can help you calculate income and expenses to provide a dashboard view of your financial situation.

2. Determine your emergency fund goal

A budget is a spending plan that helps you to determine how much money you need each month to cover essential expenses. This number can be calculated by adding up monthly costs for housing, food, transportation and other necessities and then multiplying the sum by six, which gives you the amount you need to cover six months of expenses. It will take most households some time to reach the six-month goal.

3. Set up a direct deposit

Direct deposit automatically deposits your paycheck and other funds directly into your checking or savings account, eliminating the need to manually deposit checks. But all your funds needn’t go into just one account. Setting up a split direct deposit allows you to direct a specific amount of money to your emergency fund with the remainder going to your checking account or vice versa. There are also savings apps that can automatically transfer a percentage of your paycheck into a savings account.

Automating the process not only simplifies saving, it can also help keep you on track toward your savings goals.

4. Gradually increase your savings

Over time, increase the amount you’re contributing to your emergency fund by 1 percent or a specific sum, until you’ve reached your savings goal. Increasing the amount in increments can help to make the smaller deposit into your checking account appear less noticeable.

5. Save unexpected income

At least a part of any windfall that you receive should be used to add to an emergency fund, unless you already have a sufficient one established. Unexpected money can come in the form of a tax refund, bonus, cash gift, inheritance, or winning a contest or the lottery.

6. Keep saving after reaching your goal

Some emergencies require more than a six-month cushion. Being unemployed for more than a year or being hospitalized for several months are both situations where you’ll be glad you have more money saved in your emergency fund.

7. Use a bank account bonus to jumpstart your savings

Banks frequently offer cash incentives to new customers for opening new checking or savings accounts. The additional cash can be useful in establishing an emergency fund or adding to an existing one.

Bottom line

An emergency fund is the best way to save for unplanned events. It can eliminate the need for taking on credit card debt or accumulating a personal loan. Putting your emergency savings in a high-yield savings account allows you to earn interest while you build your nest egg.

Having an emergency fund separate from your checking account can prevent you from spending that money and ensure that the money is there should an emergency happen.

Emergencies can happen whether you’re prepared or not, so planning ahead is the best way to help your future self handle a potentially difficult situation.

Note: Bankrate’s René Bennett also contributed to this story.