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In Finance, what is an Emergency Fund?

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  • Written By: B. Miller
  • Edited By: Andrew Jones
  • Last Modified Date: 24 September 2016
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An emergency fund is a cash reserve held in case an emergency leading to a loss of income should arise. It is generally recommended that individuals or families save from three to eight months' worth of living expenses in a savings account in order to stay afloat after the loss of a job or an unexpected major expense. This savings account is referred to as an emergency fund, and should not be touched unless absolutely necessary.

To start an emergency fund to guard against future money problems, begin by opening a separate savings account at a bank. Determine the amount of money that can be regularly deposited into the account, either bi-weekly or monthly. It may be necessary to closely examine one's expenses to determine where cutbacks can be made. It may be beneficial, then, to set up an automatic withdrawal from a checking account into the savings account every time a paycheck is deposited. That will make the money absence less noticeable, particularly if it is a relatively small percentage that will add up over time.

It is also necessary to determine the amount of money that is needed in order to survive for a certain amount of time. Again, take careful account of monthly expenses, selecting ones like groceries, mortgage, gas, medications, and food that are absolutely necessary, and add those up. The emergency fund should be able to cover at least three months of these necessities.

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Keep in mind that an emergency fund can take years to build. It is important to fund a retirement account at the same time, particularly if a company offers some sort of contribution-matching program. In addition, those with high amounts of credit card debt might first want to focus on paying that off. This is because it does not make much financial sense to have thousands of dollars sitting in an emergency fund only earning three percent interest, while a credit card company is charging 18 percent interest or more on a high balance.

There are many benefits to having an emergency fund. If a job is lost, a medical emergency happens, or a home needs expensive repairs, the emergency fund can be used without needing to take out a loan or running up high balances on a credit card. Careful money management and a regular assessment of expenses can go a long way towards funding one's future. An emergency fund is just one part of successful finances, but many people believe it to be the most important part to guard against disaster.

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