How to Build an Emergency Fund

It’s a key component of any sound financial plan

By 

THE INVESTOPEDIA TEAM

Updated June 29, 2022

Reviewed by PAMELA RODRIGUEZ

Fact checked by MARCUS REEVES

Having an emergency fund is a necessity. Think of it as a shock

absorber for the bumps of life, one that’ll keep you from adding to the
load of debt you most likely already carry. The coronavirus outbreak
has shone a giant spotlight on the difference having an emergency fund
makes when a crisis hits.

Read on for details on how to build an emergency fund and just how
much you’ll need to save for it.

KEY TAKEAWAYS

 An emergency fund is a key component of any good financial

plan.

 The rule of thumb is that you need to keep between three and six
months’ worth of household expenses in your emergency fund.

 In order to populate your fund, you should find ways to economize

and contribute those savings—along with any financial windfalls—
to it.

What Will You Need?

While some call having one to two months’ wages in reserve ideal, most
financial experts say that the recommended emergency fund amount
should cover three to six months’ worth of household expenses.
That’s a great idea, and a key part of any sound financial plan , but it
also requires some effort to achieve.

The first step in the process is to figure out how much you spend each
month. Consumer expenditure figures released in April 2019 by the U.S.
Bureau of Labor Statistics indicate that the average annual expenditure
per consumer unit, which is similar to a household, was $60,060 in 2017
(the most recent year for which data is available).1 This data is broken
down by month in the table below. The months in bold highlight the
cumulative quarterly expenses, and therefore, the recommended cash
reserve for the average household.

Number of Cumulative Expenses

Months

1 $5,005

2 $10,010

3 $15,015

4 $20,020

5 $25,025

6 $30,030

While your household expenses may be higher or lower than the

average, there’s no doubt that even three months’ worth of expenses is
a big number. One look at that number and the average person’s first
reaction is, “I can’t come up with that kind of money.”

Why So Much?

The amount of money required to populate a proper emergency fund is

certainly significant, but we live in uncertain times with uncertain
economies, especially in the wake of the coronavirus. Corporate loyalty
is a thing of the past, and unemployment can happen unexpectedly,
usually at the worst possible moment. Even without a global crisis,
emergencies such as sudden illness or disability, major car repairs or a
new roof, can be expensive, and there’s never a good time for these
things to happen.

While it’s probably true that you don’t have an extra $15,015 lying
around, everything is relative. Even six months’ worth of expenses is a
puny number compared to the amount you will need to save for
retirement, and there’s not a savvy investor out there who balks at the
idea of stashing away so much money that they will never need to work
again. When compared to what you’ll need over the course of 20 or 30
years in retirement, three months’ worth of expenses doesn’t look like
much.

Though the amount of money needed in your fund may seem daunting
at first, remember that it is a drop in the bucket compared with the
amount you will have to save for retirement.

Crunching the Numbers

With that perspective in mind, let’s consider how to save for an

emergency fund. Approach this effort the same way you would
approach any other financial goal. Put together a plan and execute it.
The first step is to determine how much you spend each month.
Housing, transportation, and food will likely be the categories that eat
up most of your cash. The average household spends 62% of its
income, which averages $73,573 before taxes, on these items,
according to the BLS Consumer Expenditures report.1

Once you know your total expenses for each month, multiply that
number by three. Reaching that number will be your initial goal. To
achieve your three-month target, you need to start saving money.

If we assume your initial goal is $10,000, the table below illustrates how
much you will need to save each month, over a five-year or two-and-a-
half-year period.

Five-Year Amount Needed per Two-and-a-Half-Year Amount Needed per

Plan Month Plan Month

60 months $166.67 30 months $333.33

Putting Your Plan into Action

Buying a less expensive car the next time you are shopping for an auto
and downgrading your cell phone service are two easy ways to come up
with some cash to fund your savings plan. Skipping that two-week
vacation, cutting down on the amount you spend dining out, and saving
your next raise or bonus are also achievable methods of adding to your
emergency fund.

The key is to add to the fund at regular intervals. Ideally, you should
treat it like any other recurring bill you must pay each month. Dedicate
the appropriate amount from your paycheck and set it aside. While most
people have no qualms about regularly sending enormous amounts of
money to credit card companies, they balk at the idea of paying
themselves first. Change that equation.

If you are among the many investors who don’t have a rainy day fund
stashed away in case of emergencies, there’s no time like the present to
start saving. Even if you don’t have the fortitude to address the project
with a dedicated savings program, you can start simple: Take the
change out of your pockets at the end of the day and put it in a jar. Look
into micro-investing platforms, such as Acorns, that round up
purchases made from linked accounts and collect and invest the
change.

You could also eat at home instead of dining out and “tip” yourself by
adding a few bucks to your emergency fund. If you get cash back on
your credit cards or just paid off a big debt, such as a personal loan or
an automobile, put that newfound money into your fund. If you get a tax
refund, deposit the check into your fund. If you manage to dedicate just
$5 per day to your effort, you’ll have $1,825 at the end of the year; that’s
$9,125 in just five years.

Where to Put the Money

Money market funds and high-interest savings accounts  are two good

places to park your emergency fund. You need safe, liquid options  so
that your money is accessible in times of need. These choices make it
harder for you to dip into it (face it: you’ll be tempted to from time to
time), and you’ll also earn a bit of return on the money.

The Bottom Line

View your emergency fund like an insurance policy. Once you have it,
guard it carefully. It’s not a piggy bank. You should not using it for
incidental expenses. In fact, as your salary rises, be sure to up the
amount to match your new situation.

Use the fund only in the event of an emergency and spend it carefully
when you do need to draw on it. Remember, once that money is spent, it
always takes much longer than anticipated to replace it. Start now and
save whatever you can, even if it isn’t much. Having an emergency fund
gives you a better shot at weathering a crisis without running up a
credit card balance or taking out a personal loan.

Compete Risk Free with $100,000 in Virtual Cash

Put your trading skills to the test with our FREE Stock

Simulator. Compete with thousands of Investopedia traders and trade
your way to the top! Submit trades in a virtual environment before you
start risking your own money. Practice trading strategies so that when
you're ready to enter the real market, you've had the practice you
need. Try our Stock Simulator today >>