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How to build an emergency fund on any budget

Heather Petty
Updated
How to build an emergency fund on any budget (J Studios via Getty Images)

Unfortunately, emergencies happen. And as recent global events and rising costs have proven, not everyone is prepared to face an unexpected expense or financial emergency.

While 62% of Americans say saving for an unplanned emergency is important, 47% feel they aren’t able to save because their household expenses are too high, according to a recent Empower survey. That gets even trickier for seniors and retirees, who are either saving for retirement or living off a fixed retirement income.

You may not consider an emergency savings account a priority. But when you’re living on a limited income, having easy access to money that can help you through a crisis provides the financial security and peace of mind you deserve.

Learn how to build a rainy-day fund, how much to save and tips to stay motivated while paying down your debts.

An emergency fund is an amount of money set aside for times of unexpected expenses or lack of income. If you own a house or car, for example, an emergency fund can help you cover your insurance deductible or pay for unplanned repairs that aren’t covered by insurance. If you’re still working, an emergency fund can be helpful for covering an extended leave of absence or gaps in employment.

Any number of unexpected situations can lead to unplanned expenses outside of your normal budget. An emergency fund can help you navigate those situations with less stress — and without having to go into debt or dip into your long-term investments or interest-earning savings.

Some financial experts suggest having two emergency fund amounts on hand, depending on your circumstances — one for unexpected expenses and one for loss of income:

  1. Emergency expenses. Most advice suggests your starter fund should be at least $1,000, but you may consider a fund that’s half of your monthly expenses. So, if your rent and other expenses equal $4,000 a month, having $2,000 in an emergency account can help you pay for a simple emergency.

  2. Loss of income. If you’re gainfully employed — especially if you’re the main breadwinner for the family — the rule of thumb is three to six months’ worth of expenses in an emergency fund that can keep your finances afloat after a job loss. That would mean saving up at least $12,000 if your monthly expenses total $4,000.

But these are general guidelines that won’t apply to all situations. If you’re living paycheck to paycheck, you may not be able to spare much for your savings. Just keep in mind that every dollar saved provides for stronger financial security when you need it most.

“More savings, less stress” may sound like the key to surviving an emergency, but you shouldn’t keep more than six months of expenses in an emergency fund. Your fund needs to be immediately accessible, and even in a high-yield savings account earning 10 times the national average, you’d be missing out on higher yields elsewhere. Any excess in savings should be invested to make you more money over the long term.

If you still haven’t resolved your financial situation after six months, or you need more funds than you’ve saved, you can always dip into your investments. But in the meantime, those funds will be earning interest and building your wealth.

Dig deeper: How much should you keep in a savings account?

You want your emergency fund to be separate from your day-to-day checking account but easily accessible when you need it — which means it’s not tied up in a long-term investment, like a CD or other holding that can take time to access or charge early withdrawal penalties.

Most traditional banks and credit unions offer basic savings with interest rates averaging a very low 0.45% on your account balance. You won’t make much money with that kind of account, but you can usually start a savings account with just a few dollars, and keeping money in your bank can allow you to quickly transfer the money to a higher-yield account later.

Still, you have three main options for your emergency fund that will also earn you decent rates of interest, helping your money to work harder on your behalf:

  • High-yield savings account. If you’re comfortable with online banking, many digital banks offer high-yield accounts with APYs as high as 5% or more. These accounts typically don’t require minimum deposit amounts, maintenance fees or other limitations on what you can earn, with compounding to grow your money faster. And you can open a high-yield account online in minutes.

  • Money market account. A money market account is a type of high-yield account with competitive interest rates, often with limited checking and debit privileges. But withdrawals may be limited to a set amount annually and the accounts can come with monthly, annual, or per-withdrawal fees. To get the best rates, you may need to keep a specific amount in the account, make direct deposits monthly or meet a number of other requirements.

  • Money market mutual fund. Not to be confused with a money market account, a money market mutual fund puts your money into mutual funds that invest in short-term loans to companies and governments. These loans earn interest over their short term, generating passive income while remaining highly liquid. Keep in mind that money market funds use brokerage accounts, so they don't offer FDIC or NCUA insurance. This means that you could lose money in a market downturn.

Dig deeper: High-yield savings vs. money market account: Which is best for growing your money?

Living on a fixed income might make saving money feel impossible, but every dollar saved is that much more security for you going forward. Follow these basic tips that can help you find a way to build an emergency fund, pay for unexpected expenses and keep it growing for future stability.

There’s no one-size-fits-all approach to budgeting, but an easy start is creating a list of your income and all of your monthly expenses. Like most people, you might be surprised at the extra money you have available every month.

But whether you have a noticeable sum to slip into savings or not, look for places you can cut back or find cheaper services that will allow you to fund your emergency savings. And when you’re ready, you have several popular budgeting strategies to choose from that can fit the way you save and spend.

Read our guides to budgeting and saving money

Your ultimate goal may be to accumulate six months of expenses into an emergency fund. But a $10,000 goal may seem like too high a bar, if you can only spare $5 or $10 a month. Setting smaller, more easily reached goals can help keep you motivated and on track, even when things get difficult.

One way to make sure your monthly savings makes it into your emergency account is to automate the transfer. Most bank accounts allow you to set up automatic transfers that move over a specific amount into a savings account at a set time each week or month around paychecks or benefit schedules. Some even give you the option to set up “buckets” within your account for budgeting and special savings projects. Think of your monthly contributions to your emergency fund as an automatic payment you’re making to yourself, so you’re not tempted to spend it.

Dig deeper: Best cashback apps to stretch your dollar — and earn rewards on your shopping

Saving is no small feat, so you should celebrate when you reach your goals. Maybe you could indulge in a small luxury you’ve been doing without — or, even better, find a money-free way to celebrate, like an in-home spa night or a picnic lunch in your favorite nature spot. Regardless, make sure it’s something that will help motivate you to keep feeding your emergency fund.

Whether your sibling finally pays back that money you loaned them, you get an unexpected inheritance or tax refund, sell something or receive a cash gift, it can be easy to spend that bonus income before you know it’s gone. But if you make a rule that a percentage of any windfall goes into your emergency fund, you'll not only make sure to do something productive with the money, but also reach your next goal — and celebration — a little faster.

Make an appointment with yourself to check in on how your emergency fund is growing, whether that’s quarterly, annually or every time you reach a new milestone. This can also be a great time to revisit your budget and see if you’re able to increase your contribution to the fund. There’s no shame if you can't — or even if you have to decrease the amount you’re saving, if you’ve been a little too ambitious.

You might consider taking time to shop around for the best savings accounts and highest yields available on the account you keep your emergency fund in.

The money in that fund is there for when you need it, but you never know when you’ll need it again. Make sure you replenish whatever you used as soon as possible, so you’re ready for whatever comes next.

What constitutes an emergency isn’t something someone else can define for you. It’s not always even something you can predict. But you can set some rules for yourself to ensure you don’t misuse the money you worked so hard to save.

Creating a list of emergencies — both small and large — may help, including:

  • Car repairs

  • Unexpected medical bills

  • Dental or vision needs

  • Necessary home repairs

  • Loss of income or a short income check

Your emergency may not be on this list, but that doesn’t mean you shouldn’t use your funds to cover an unexpected financial need. After all, that's what it's there for. You can always start saving again to build that fund back up, this time knowing how much you appreciated having the safety net when you needed it.

If you have a lot of credit card or other high-interest debt, it may be hard to decide which is more important: paying down your debt or saving for an emergency. Any loan or credit line with a high interest rate is padding your debt every month you don’t pay it down. But not having an emergency fund may cause you to go further into debt.

The answer isn’t an easy one, but it’s good to start with a simple strategy like the debt snowball or debt avalanche methods. Each strategy focuses your finances on cutting down your overall debt, with differences coming down to where you apply the rest of your money next — and how you’re best motivated to pay off debt to zero.

Learn more about these debt-payoff strategies and how they work in our guide to the debt snowball and debt avalanche methods.

Even if you go with a different strategy, a balanced plan should have you setting smaller savings goals and — after you’ve built an emergency fund — paying off your higher interest debts before getting back to savings.

Dig deeper: 5 debts to prioritize paying off before retirement

Learn more about how savings accounts work, including how your money is protected when growing an emergency fund.

No, and for two key reasons. First, your checking account is designed to hold your most accessible cash for everyday expenses, like regular bills or costs of living. You’ll want a separate account for longer-term savings that isn’t as easy to tap into. Also, while some high-yield checking accounts pay out interest on your balance, standard checking accounts offer very low rates when compared to traditional and especially high-yield savings accounts, if at all. Learn how to find and open a high-yield account to safely grow your emergency savings.

High-yield CDs offer competitive interest rates that can grow your money faster than a traditional savings account. But it's not a great place for an emergency fund due to withdrawal penalties you'll pay if you need the money before your term matures, and even no-penalty CDs come with limitations and trade-offs. Learn more about the benefits and drawbacks of these timed deposit accounts in our guide to CDs and how they work.

Losing your money in a high-yield savings account isn’t likely, especially at banks, credit unions and financial institutions backed by federal insurance of up to $250,000, but you could lose money to common bank fees, low rates and more that can eat into your earnings. Learn more in our guide to the top 6 risks to watch for with a high-yield savings account.

Most traditional banks and credit unions are FDIC-insured to offer deposit accounts protected by the government for up to $250,000. Look for terms like "member FDIC," "FDIC insured" or "NCUA insured" when comparing your options. If your bank isn’t insured directly, it could partner with a more recognizable FDIC-insured bank to make sure your money and the interest you earn is protected. Learn more about how to confirm your bank is FDIC-insured.

Compound interest is often described as earning interest on your interest. It’s a powerful way to boost your savings over time by earning interest on both your initial deposit and any interest you earn along the way. An account's APY is the total amount of interest you'll earn on your deposit over one year, including compound interest, expressed as a percentage, with many HYSAs compounding daily or monthly. Learn more in our guide to the power of compound interest.

Heather Petty is a finance writer who specializes in consumer and business banking, personal and home lending, debt management and saving money. After falling victim to a disreputable mortgage broker when buying her first home, Heather set on a mission to help people avoid similar experiences when managing their own finances. Her expertise and analysis has been featured on MSN, Nasdaq, Credit.com and Finder, among other financial publications. When she's not breaking down the complexities of finance, she's a young adult mystery writer of an internationally acclaimed series — and counting.

Article edited by Kelly Suzan Waggoner

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