What is an emergency fund?

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• Emergency savings can help cover large, unexpected expenses and protect you in case of job loss.
• Most experts recommend having around three to six months of expenses saved up. 
• Failing to have an emergency fund could mean needing a costly loan or racking up credit card debt.
• Compare the best high-yield savings accounts.

Having cash available for emergencies is critical. Without it, a sudden medical bill, job loss, or other unexpected change could send your finances into upheaval. You might even need to take out a costly emergency loan or rack up credit card debt just to get by.

Unfortunately, these scenarios are more common than you might think. Only about two-thirds of Americans say they can cover an unexpected $400 expense in cash, according to the Federal Reserve. 

Do you have a flush emergency fund to weather potential storms? If not, here's what you need to know.

What is an emergency fund? 

Emergency funds are savings you set aside for unexpected costs — like home repairs or medical bills, for example.  

"It is literally just money that you set aside that you would have available in an emergency," says  Ashlee Walton, a CFP® professional at James Investment Research. "If no other dollars are available, these funds could be used to pay for unexpected expenses such as car repairs or a hot water heater or to pay bills if you suddenly lost your job or had a medical emergency."

Emergency funds can ease financial stress when unforeseen costs arise. They can also help you avoid the unwanted consequences of borrowing money or, in dire scenarios, not paying your bills altogether.

As Walton explains, "With no emergency savings, you could be stuck paying high fees to borrow money, taking costly distributions from retirement accounts, or worse, unable to pay expenses and potentially losing your home, car, or other assets."

What can I use an emergency fund for? 

An emergency fund should be used for unforeseeable expenses that are important to pay off. This can be a mortgage or car payment, or some other expense that is of equal importance. You should dip into it only if you have to — if you've lost your job or something else causes a disruption in your income.

"Emergency funds should only be used for needs, not wants," says Jay Zigmont, a CFP® professional, founder of Live, Learn, Plan, and a Registered Investment Advisor based in Mississippi. "Needs are things that you must pay for or must do, such as repairing the roof on your house. A kitchen remodel is a want, not a need. New tires for your car when the others are bald is a need; a new car is a want."

Having a flush emergency fund is also important in uncertain economic times, Zigmont says. These days, with inflation and other economic factors at work, there's no telling when cash reserves might come in handy.

"If there is anything that the last few years taught us, it is that emergencies happen," Zigmont says. "Emergencies are often out of our control and are more than just the loss of a job. The key is to have a cushion when bad times hit as part of our everyday life.

How much money should you save for emergencies? 

As a general rule, most financial experts recommend having at least three to six months of living expenses in your emergency fund. This ensures you're able to cover crucial expenses for a few months if you lose your job, have a sudden change in health that affects your ability to work, or if you experience some other unexpected life event that negatively affects your finances. 

But having three to six months' of expenses isn't a hard rule for everyone — sometimes you may need to save more than that. To determine how much you should actually save, you'll want to tally up all your household expenses for the month, including your mortgage or rent payment, your insurance costs, and important costs such as utilities, groceries, gas, and childcare. 

Depending on your circumstances, you may actually need to save more than three to six months, particularly if your earnings fluctuate or you rely on only one stream of income. If you anticipate needing home repairs sometime soon, have health problems, or have a job that would be particularly hard to replace, this may also call for additional savings.

"It can depend on personal preference, job security, and anticipated short-term large expenses," says Antonio Tovar, a CFP® professional and wealth manager at Stone Wealth Management. "A real estate agent that works on commission may feel more comfortable with more cash on hand than someone who has worked for the state for 20 years, or if you are anticipating a water heater replacement, then it would be appropriate to hold a little more cash than normal."

How to build an emergency fund

If you don't have an emergency fund yet, financial educator Amy Maliga says to start small and work up from there.

"Many Americans are unable to pay for an unexpected $400 expense, so if you're starting your emergency fund from scratch, shoot for an initial savings goal of $500," Maliga says. "This will cover many common emergency expenses, such as a typical car repair. Once you reach that goal, keep going and contribute to your emergency savings every time you get paid. To make it grow faster, you can also deposit any bonuses, overtime wages, cash gifts, or money you make from side hustles."

To build up your emergency fund, consider setting up a direct deposit that funnels part of each paycheck into your savings account. You can also set up an automatic transfer from your checking account each month or configure a calendar alert to remind you to do the transfer manually.

Where to store your emergency savings

Emergency funds need to be liquid — which means they should be easily accessible and not tied up in real estate or other investments that would be difficult or time-consuming to convert to cash. Although physical cash is an option, that might come with some temptation, so that option isn't recommended. 

The best place, experts say, is in a savings account — ideally one that allows you to earn interest on the cash when you're not using it.

"I recommend a combination of cash and a high-yield savings account," Zigmont says. "I like to keep $1,000 in cash on hand as it is enough to get you through quick emergencies." 

When choosing a high-yield savings account, Zigmont suggests choosing a different bank than the one you usually bank with. "The idea is to have it slightly removed from your eyesight and to set up a small barrier to using it," he explains.

Interest rates on savings accounts can vary from one bank to the next, so compare options before opening yours. In some cases, money market accounts can be useful, too. 

"You can consider money market accounts, as they can have slightly higher interest rates than savings accounts and provide ease of access," Tovar says. "However, be careful about putting your cash into short-term savings instruments like CDs or Treasuries, because if you need the funds and you either must pay a penalty or cannot gain access to the funds yet, then you could be in a bad position or receive a reduced amount. Ultimately, this cash reserve should not be viewed as an account to expect growth; it's simply a fund for emergencies."

When to use your emergency fund 

You should tap into your emergency fund only when absolutely necessary and never for nice-to-haves, like vacations, clothes, or dining out.

"If you aren't sure, then it probably isn't the right time," Walton says. "It really should be when you have no other decent choice."