Build an Emergency Fund (Part 1)

Everyone's experienced unexpected financial emergencies—a fender bender, an unexpected medical bill, a broken appliance, a loss of income, or even a damaged cell phone. Large or small, these unplanned expenses often feel like they hit at the worst times.

Setting up a dedicated savings or emergency fund is one essential way to protect yourself, and it's one of the first steps you can take to start saving. By putting money aside—even a small amount—for these unplanned expenses, you're able to recover quicker and get back on track toward reaching your larger savings goals.

What is an emergency fund?

An emergency fund is a cash reserve that's specifically set aside for unplanned expenses or financial emergencies. Some common examples include car repairs, home repairs, medical bills, or a loss of income. In general, emergency savings can be used for large or small unplanned bills or payments that are not part of your routine monthly expenses and spending.

Why do I need it?

Without savings, a financial shock—even minor—could set you back, and if it turns into debt, it can potentially have a lasting impact. Research suggests that individuals who struggle to recover from a financial shock have less savings to help protect against a future emergency. They may rely on credit cards or loans, which can lead to debt that's generally harder to pay off. They may also pull from other savings, like retirement funds, to cover these costs.

How much do I need in it?

The amount you need to have in an emergency-savings fund depends on your situation. Think about the most common kind of unexpected expenses you've had in the past and how much they cost. This may help you set a goal for how much you want to have set aside.

If you're living paycheck to paycheck or don't get paid the same amount each week or month, putting any money aside can feel difficult. Even a small amount can provide some financial security. (Part 2 of this article will help you find the savings strategy, or strategies, that work best for you.)

Where should I keep it?

Where you put your emergency fund depends on your situation. You want to make sure this fund is safe, accessible, and in a place where you're not tempted to spend it on nonemergencies. Here are a few options for where to put your emergency savings, and you can choose the one that makes the most sense for you:

• Bank or credit union account—If you have an account with a bank or credit union—generally considered one of the safest places to put your money—it might make sense to have a dedicated account where you can keep and maintain these funds.
• Prepaid card—A prepaid card is a card that you can load money onto. It's not connected with a bank or credit union, and you can only spend the amount that's on your card.
• Cash—Another option is keeping money on hand for emergencies, either in your home or with a trusted family member or friend. Keep in mind that cash can be stolen, lost, or destroyed.

When should I use it?

Set some guidelines for yourself on what constitutes an emergency or unplanned expense. Not every unexpected expense is a dire emergency, but try to stay consistent. Even if it's not a trip to the emergency room, you may need it to pay for a medical bill that wasn't covered by insurance.

Having a reserve fund for financial shocks can help you avoid relying on other forms of credit or loans that can turn into debt. If you use a credit card or take out a loan to pay for these expenses, your one-time emergency expense may grow significantly larger than your original bill because of interest and fees.

However, don't be afraid to use it if you need it. If you spend down what's in your emergency savings, just work to build it up again. Practicing your savings skills over time will make this easier.