What is the Purpose of an Emergency Fund – How It Works

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Emergency funds might sound like something new, or something you’ve heard of several times in the past. You may have one or you may not. According to statistics, though, if you reside in the U.S. in 2020 there’s only about a 41% chance that you have an emergency fund.

And about 19% of Americans only have up to 2 months worth of expenses covered with funds currently in their bank according to GOBankingRates.

These types of statistics are the very reason why it is essential for us as Americans to learn about the importance of an emergency fund. What is the purpose of an emergency fund?

In short, the purpose of one is to protect your livelihood in the case of an emergency. This way, you are able to stay afloat without needing to accumulate more debt.

In the following paragraphs, I will be going in-depth into the intricacies of an emergency fund.


How Does It Work?

An emergency fund is money that is set aside to cover large and unexpected expenses. The emergency fund is designed to create a type of buffer for your financial situation. This way, you are able to keep up with mandatory expenses during an emergency without relying on credit cards or taking out loans.

These expenses can be an array of situations encompassing the following:

  • Unemployment
  • Home Appliances (food, gas, water, rent/mortgage, etc.)
  • Home Appliance Reparations (AC, Heating, Plumbing, etc.)
  • Automobile Reparations
  • Medical Expenses
  • Any other mandatory expenses

We as humans may sometimes come across the temptation of using this fund to purchase something that we can’t afford with our regular checking account, even if we don’t need it. That new phone is not an emergency. If you need a new phone but you don’t have enough money right now to purchase the best next thing, stick to something more affordable.

That emergency fund is strictly for unforeseen, mandatory emergencies.

How Much Should I Save for an Emergency Fund?

This is particularly different for every person. To determine the minimum you will need to save for an emergency, audit the past three months’ worth of expenses. How much did you spend on mandatory expenses? What else would you like to cover in the case that you no longer have the income to cover it? Now multiply that by 2.

Depending on your financial circumstances this has to be AT LEAST six months’ worth of expenses. I personally like to keep mine for a whole year’s worth. And still, I keep adding to it. I simply don’t add as much as I did when I first started it because now I’ve reached the goal that I originally had.

I recommend starting your emergency fund with about $1,000. You’d be surprised how much $1,000 can help you out in the case of an unforeseen expense. Though this is not what you should be aiming for, this is only a start.

Start with $1,000 and build it over time, the key is to start NOW!

How Do I Build/Fund An Emergency Fund?

There are several ways in which you can build an emergency fund. However, they all involve the discipline to control your emotions, delay gratification,  and control your daily spending habits. Financial success overall depends heavily on your own emotional discipline.

Here are some quick tips to follow to build an emergency fund. You can either follow one of these or use more than one of these tips to speed up the process.

  • Sell things
    • Look at your home. What do you use? What do you not use? What do you need? What do you not need? Whatever it is you’re selling, list it on an online marketplace for the easiest selling avenue. Facebook marketplace is a great option, but it’s not the only one! You could also look into a garage sale or other selling avenues that don’t involve online movement.
  • Save your tax refund.
    • Put it all in your emergency fund if you don’t need it for any necessary expenses.
  • Automatic transfers
    • Every time you get paid, set money aside to go to your emergency fund. Now you won’t be thinking about it or forgetting to fund that account. It’s an automatic thing. You could even ask your employer to directly deposit a certain portion of your money to the emergency fund.
  • Set monthly saving goals
    • Short-term goals tend to do the trick! The shorter the goal, the more accessible it seems, and the easier the process gets to reach that goal. Baby steps go a long way to reach one ultimate goal.
  • Keep the change
    • Did you get $0.71 worth of change on your last purchase? Save it! You’ll be surprised to see how that and other change will start to add up over time. Don’t use cash? There are apps for this too!
  • Side-hustle, second job, or both!
    • Getting a second job might not be what you may be looking for right now, but it will pay off later. If you don’t need the extra income from the second job for anything else, put it into your emergency fund! You’ll be very grateful that you did when an emergency arises. You will have that money there to back you up!
    • Side-hustles are an excellent option because you don’t necessarily need to go through the whole process of getting a new job. Grab a lawnmower and go mow the yards of people who are willing to pay someone else to do it. Paint someone’s fence, start an online gig. All these options could even become a full-time gig providing you with more income than your current job! Do anything that gets you extra money. Doing this and/or a second job will also skew you away from having time to spend your money. By default, you’ll end up saving more.

None of these options may look like easy tasks. They are simple, but they may be difficult to keep up with. Ultimately, you have to make the decision to discipline yourself. Make the decision to put a little extra effort to not let the next unforeseen expense put you in a hole of debt.

Where Does an Emergency Fund go?

An emergency fund ideally needs to be in a separate account from your usual checking account. The reason why is that when it is easily accessible in the same account as your usual spending account, it is a lot easier to spend it. Every time you are tempted by impulsive spending behaviors, it will be spent.

This defeats the whole purpose of the emergency fund. At the moment you may give yourself excuses to justify your impulsive purchase. You might convince yourself that it was a good choice, when in fact it wasn’t.

You also want to make sure that the account in which you put your emergency fund is building compound interest. There are several options for this. You usually want to go with online banks like Marcus by Goldman Sachs (for its high-yield savings accounts), online firms like Wealthfront (for its high-yield cash account), or money market accounts.

Make sure that your money is earning more money. That compound interest really adds up!


Get to Action!

Now you have it! You know what you need to know about building an emergency fund.

You know about its importance. You know where you can park it. You know how you can build it, and how much you should aim to put in it.

Now you have no excuse in the future to be dealing with heavy financial drawbacks; unless they catch you before your emergency fund as been fully funded. Even then, though, the money in that fund will serve you greatly and put you much closer to getting out of a financial ditch.

Now you must get to the action! Open an account where you can start adding money and get the ball rolling. Make sure your next paycheck has a portion that will specifically be going towards that emergency fund. Even if you haven’t audited your last three months, start at $1,000. From there, add what you can afford to add. If you can’t afford a whole $1,000 now, make that your first goal. From there, set another goal.

This will help you start to move forward with your emergency fund. To make sure you have something to fall into when a financial drawback arises. Get to action!

If you have any questions or comments at all, feel more than free to leave them in the section below. I will be happy to respond to each of them.


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53 Comments

  1. You know, I just came down with some kind of debt and someone mentioned to me why I didn’t have an emergency fund, I didn’t understand what it meant so I had to come online to learn about it even better and now that I am reading your post, I like it a lot. I think this is what I need to do and it might be something that will help me in the future too. You’re a life saver. Thanks.

    1. Absolutely! Glad I could be of help. Emergency funds are an amazing start in building your wealth. This simple step puts you ahead of over 50% of Americans and it’s super simple to understand. I’m glad I’m able to help people like you on their journey.

      Thank you for your feedback 🙂

  2. Hello there, thanks for sharing this with me, I know it would definitely be of great help to other out there.i never really knew the importance of emergency funds, not until now I never knew they existed…but I think I have to make plans so as to have them in good reach.

    1. Definitely, having that access to liquid cash is a tremendous aid. But like I said in the article, make sure you have it in a high-yield savings account so that it earns you some money and it’s not just sitting there. I’ll write an article on some options that can give you some high yield. Thank you for your feedback!

  3. Hello there, making sure of money is a really huge skill that most of us need to learn because sometimes we end up spending time and wasting the good memory we own and should have spent in a good manner. I have been really happy with seeing how to spend and emergency fund because a friend is in such situation and this would do a lot of help to her.

    1. I’m glad I could be of help! 🙂

  4. Sometimes, things happen and life might toss a very unexpected face of the coin to us and the best thing to fo is to rise up to it. Hence that is why it is really expected to have backup plans and know a way to go about things when such happen. Knowing how to raise the right funds in advance for such situation is really great and thank for sharing here

    1. Of course! Emergency funds are vital to a better financial future. I’m glad this served you well.

  5. Having some cash stored up for the rainy day is a very wise decision to make, it’s very good to save up some amount when you have abundance so that in times when you don’t have anything left on you, you can always turn to your emergency fund and as it is, you won’t be broke. Most people don’t understand this fact, but this article will explain better.

    1. Absolutely! Thank you for your feedback 🙂

  6. An emergency fund is money that is set aside (ideally in a separate account from your usual bank account) to cover large and unexpected expenses. The emergency fund is designed to create a type of buffer for your financial situation. So that you are able to keep up with mandatory expenses without relying on credit cards or taking out loans.
    These expenses can be an array of situations that medical and so on.

  7. Md. Asraful Islam

    Thank you so much for sharing with us an interesting and research article. The main subject of this article is the  Purpose of an Emergency Fund. It is truly commendable that you have demonstrated this topic so well in your article. I have learned a lot by reading your article and gained a lot of cognition about it. Of the points mentioned in your article, I like how Do I Build An Emergency Fund? When we need to spend our savings in an emergency, of course, it comes in handy, which is something we have saved over the years from a variety of products or from our own paychecks.
    Finally, I enjoyed reading your article and I’d like to share your article in my Facebook group if you give me permission.

    1. Absolutely! You are more than welcomed to do so. Always happy to help as many people as I can. Thank you for your feedback and for sharing this with others! 🙂

  8. Thank you very much for answering my questions concerning an emergency fund. I must admit that I had a misconception about it. Thank you for encouraging to set apart money to create an emergency fund. If something I have learnt from this pandemic is that we have to be always prepared for big changes.

    1. 100% agree. Many people have learned very valuable lessons from the misfortunes of this pandemic. It’s my goal to be able to help people learn these lessons without having to go through the negative experiences, and instead, through a trusted source of information. I’m glad I could help! And thank you for your feedback!

  9. This information is great for anyone who seriously wants to make sure the love ones is taking care off. 

    This lockdown, now 5 months, it would have been the ideal scenario to practice what you advice in your post. As you remarked only 50% of Americans have an emergency fund. Anyway is a valuable advice, and I think people may take your well researched advice, more seriously.

    Thanks for the post, and a clear reminder.

    1. Thank you! It’s a big part of the reason why I decided that helping people out with their finances is a very good thing for the world. This pandemic has shown the world how unprepared we really are. It takes the ones who like to look into personal finance to help others in their endeavors by getting all the finance-related stuff out of the way

  10. I found your article to be very thorough and informative for the lesser informed. I haven’t looked for the posted date but it was very appropriate for the situation that many have found themselves in (including me) since this pandemic started. If the average citizen were more financially prudent, our country wouldn’t be in the shape we are in now because we would hold our representatives in Congress more closely responsible for the budget and fiscal spending.

    Although I am like the 50% that are under-prepared for any financial emergency, this pandemic experience has brought home the prudent advice you so eloquently explained.

    1. I appreciate your feedback 🙂 I’m glad that the value of this article was good to you. I hope things have gotten better throughout this pandemic

  11. When people are asked to save or have some kind of emergency funds, threesome times feels it’s not necessarily a good idea or a waste of money bit deep down when looked into it, you’ll see more and more reasons to try it. Reading this articles and I am seeing reasons I never thought of and it gives me more reason to have an emergency fund account. Cheers

    1. I’m glad this article was of help to you!

  12. Thank you so much for writing such an informative article. To be honest, I never thought of establishing an emergency fund.  A few weeks ago my oven broke and I had to spend $1000 which I wasn’t planning to on a new one. An emergency fund might have been very handy…Your ideas on how to establish a fund seem very easy to follow so I plan to start it right away. Thanks again for opening my eyes about the importance of having an emergency fund! 

    1. Of course! Thank you for the feedback 🙂

  13. Maria Theresa Gonzales

    This is really interesting and a must do, more so, make it a habit of setting aside an amount for emergency fund.  I agree with you that the emergency fund must be on a separate account to get rid of impulsive pulling of money to buy unnecessary things.  Emergency fund should be for emergency use only.  This is one of my bucket list, thank you for reminding.

    1. Absolutely 🙂 glad it was helpful

  14. Great article and great advice. Having an emergency stash is the first part of a savings plan. I believe you should have enough to live for 12 months in an emergency fund before you start saving.

    I honestly believe we should be taught more stuff like this in school from a young age. Too many people live week to week, and if an emergency does happen, they have no choice but to go further into debt that they can not afford.

    1. I agree, and I’m glad to hear you point out that this needs to be taught at a young age. I appreciate your feedback!

  15. The past year of the global covid pandemic has made many more people aware of the importance of having an emergency fund. It was helpful to get some government assistance, but that system wasn’t 100% foolproof and there were a lot of people who struggled to make ends meet. Thanks for the reminder and guidelines to build an emergency fund.

    1. Of course! Thank you for sticking around the site 🙂

  16. I am self-employed and financially completely dependent on myself, so I am very aware of the need to have an emergency fund.
    Some time ago, when I was having financial problems and I fell into debt, I decided to take responsibility and start handling money properly. I managed to achieve this goal, in addition to the funds reserved only for emergencies, I still have enough funds to be able to survive for more than a year in the event of an emergency and could no longer work. It makes me feel free and relieved, I don’t have stress about money.
    I see you’re suggesting that we should have an emergency fund in a special account. I don’t have that, because I already have two bank accounts (personal and business), and in our country (I’m from Europe) the costs of running an account are high.
    However, I am self-disciplined, and I am aware that the purpose of the emergency fund is reserved only for emergencies, as you state in the article – unexpected major repairs in the house, unplanned car repair, case of unemployment,…

    I would really recommend everyone to create an emergency fund to the best of their ability.

    Also, tips on how to make some extra money are great, thanks!
    Friendly greeting,
    Nina

    1. I’m so glad you found value in this and I’m happy to hear that you’re financially independent. I always like to say, personal finance is what it name implies: PERSONAL. So if what you are doing has been working well for you and has continued to work well for you then that is awesome! Keep up the great work and thank you for your feedback!

  17. This is excellent advice. An emergency fund is absolutely fundamental to have financial health. I started with just $1000, I drove UBER and put it all towards my emergency fund. I can say it definitely saved my butt many times. It also provides great peace of mind knowing you have that cushion if you need it. 

    The big thing to remember about an emergency fund is that it is JUST for emergencies…sometimes I was tempted to dip into my emergency fund because of a great deal on a TV or something. Resist the temptation! Protect that emergency fund!

    1. Yes! Protect it because it will one day protect you! Thank you for your feedback 🙂

  18. This is great information! I’ve always thought that savings and financial planning should be taught to children (by parents, teachers, whoever!) before they graduate. The information that you share in the article would make a good series of lesson plans. I’m quite serious–this would be very useful information for all ages.

    Thanks for sharing these details. I can easily share this post with my friends and also those in the homeschool community!

    1. Thank you! I’m very happy to hear this has been helpful 🙂

  19. I am actually surprised that the figure is as low as 41%, as I thought it would be much higher.

    The best way to approach this is to start with small amounts and start early, as soon as they start work.  Parents should encourage their children to start setting something aside from the day they receive their first pay packet.  And then it will become a normal every day thing and they won’t think anything of it.

    I also agree that the money needs to go into a separate bank account, so that it is not spent.  They should also set up a direct debit, so that it comes out automatically every month.  

    Some employers also have schemes where they will make deductions at source and save them for the employee.

    1. That’s true! some employers do that! Thank you for your feedback 🙂

  20. The pandemic defeated all safeguards in many homes. As you articulated in your article that 3 months is ideal but  the lockdown went on for many many months and especially for the self employed, this is an unprecedented situation. 

    In my opinion in peace times your definition of emergency fund works absolutely fine.

    Nevertheless,  the article is well written and worth reading .

    Regards.

    1. Thank you for your feedback 🙂 I agree. The pandemic was a pivotal moment that showed people that they were not very well prepared for such type of situations

  21. Joseph Stasaitis

    You have provided lots of great ideas concerning accumulating and managing an emergency fund. This is something that I put together later in life as I learned more of the importance of understanding it is not how much you make but how much you save by the proper management of money. Ideas like this would be best taught in the early grades so that a person is financially astute after school regardless of their major. It is the few that are educated properly in financial basics by their family. Good insightful article that is helpful to many.

    1. You’re absolutely correct! And I really appreciate your feedback 🙂

  22. I have an excellent article in this area, and I fully agree with you, in particular, that everyone should have at least EUR 1 000 sets aside for black days. But here’s a little arguing against you because lately, you hear nothing but investing that money should not be in your bank account, just as inflation will eat up your money. Which, in your opinion, would be more profitable than investing or depositing.

    1. Thanks for your feedback Lea! 

      In response to your argument, let’s take a look at the COVID scenario that took place in March of 2020. During this time, many jobs were lost, but on top of this, security investment values ALSO dropped. So, if someone had their emergency money invested in the market at this time, their emergency fund has now dropped in value by about 40% (that’s around how much the stock market dropped during that time).

      You are now forced to withdraw that money to pay for your basic necessities because nothing else is there to cover you and you have established those losses in the market, rather than riding them off into the present where we are at new all-time highs.  

      I’m a firm believer in investing your money. But I also believe that an emergency fund should be safe from EVERYTHING. Therefore, I always advocate for placing your emergency fund in an insured high-yield savings account. You will still get more yield than a national average brick-&-mortar account.

      The high yields of these types of accounts will offset the amount that inflation will be eating up in the future.

      I actually wrote an article where I talk about where the best places to keep an emergency fund are! Check it out 🙂

  23. Hello there and what a useful article that every single person should read and learn! I do have an emergency fund and it is so important to have as especially at times as these – I agree that there are endless ways to build up an emergency fund as you mentioned and those are some great ideas and noted some of those down. Get to action indeed for those rainy days that can be inevitable – many thanks and a great read! 

    1. Absolutely! I’m very happy to hear that this has been helpful 🙂 thank you for the feedback!

  24. Hi Misael
    Thanks for sharing your views on the purpose of emergency fund and how it works. I was trying to find out ways how to save money to be used on the most appropriate time and landed on your page .Now I am in a better position to decide on how to make a reserve of extra perks I used to get from time to time. Having a separate account for this fund is a good idea.  Thanks and regards,
    Gaurav Gaur

    1. Absolutely, thank you for your feedback 🙂

  25. Thank you very much for this excellent written report. You gave me some tips even I “Dagoberta Duck”, did not know lol.
    Serious, I think a lot of people use your tips at this time. It is so important to save something nowadays. To know how to build up your emergency fund. I have done this my whole adult life. I put all my fifty cents in a glass bowl do when I come home. Once a year I can go on holiday with this.

    1. Heck yeah! I’m happy to hear that! I’m glad this was helpful

  26. Thank you so much for this very informative post!  I have very little in my emergency fund, because I have never been taught how to do that stuff, growing up below poverty.  It is nice to see that there are simple ways to start one, and I think taxes are a good way.  With everything that is going on right now, as well, it is tough from everyone because of the virus that has hit globally.  I was lucky to find a stable job before it got so bad, but I hope others have been fortunate to have money in savings for that kind of stuff.

    1. yes 100% thank you so much for your feedback 

  27. i’ve been working on my savings account and my plan is to have 3 months worth of my bills saved incase of emergency. I’ve figured out the bare minimum what i pay a month for bills, rent, phone, car. and then I keep 3 times that. Now, I’m working on have multiple revenues that I can turn to when things go wrong.

    1. Very glad to hear that! Keep up the good work

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