Discover the benefits of emergency savings. Find 4 tips that can help boost your financial health in the face of an unexpected setback.

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Personal finance

Emergency funds: 4 tips to boost your financial health

8 minute read • April 10, 2023

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Financial shocks come in all shapes and sizes and can happen at any time. They can be as minor as needing to replace a broken household appliance or as major as losing your job.

Emergencies can cause you to face challenging decisions and threaten your financial well-being. The good news—you can be ready to tackle whatever surprises life throws your way with an emergency reserve.

Benefits of having emergency savings

Setting aside money in separate accounts that are earmarked for emergencies:

Reduces stress.

Enjoy the peace of mind of being able to cover expenses without dipping into accounts designated for other goals.

Brings you a greater sense of financial stability.

Gain increased confidence from knowing where you'll get the money you need if something unexpected happens.

Boosts your overall financial health.

Check money worries off your list because your future needs are already accounted for.

4 emergency savings tips to help set you up for success

Determine your target emergency savings amount.

A common rule of thumb is to put aside enough money to cover at least 3 to 6 months' worth of critical living expenses such as your mortgage, rent, insurance, utilities, and other essentials. Of course, the amount you choose and where you save it will be impacted by a variety of personal factors such as your job, income, and expenses.

Focus on the necessities and not optional things you could cut from your budget, like dining out or entertainment.

Next, consider how much you can comfortably save each month to begin building your emergency cushion.

If you're in a strong financial position, consider saving more to cover costs beyond 6 months. This can be especially helpful if your income isn't steady or you're in a high-risk industry where layoffs are common.

On the other hand, if you're struggling to get started, begin with a small amount and build up your savings over time. As little as $50 per month gives you $600 in annual savings. To gradually increase your savings, consider:

Setting aside your annual raise or a portion of your bonus in your emergency accounts.
Looking for small ways you can reduce your daily expenses and begin saving those extra dollars.
Reducing insurance coverage if you're overinsured. While homeowners and auto insurance are necessities, weigh whether it makes sense to forego insurance on electronics, furniture, vacations, and pet care and put that money in your emergency savings.

Keep your emergency savings out of sight.

When it comes to storing your emergency savings, the saying "out of sight, out of mind" holds true. Choose an account that's separate from your go-to checking account but still easy to access. Otherwise, if it's only as far away as your everyday debit card, it can be too tempting to tap into your reserves on a whim and squander your savings.

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Consider splitting your savings between cash and investments.

To protect your money, it's important to set aside some of your emergency funds in a cash account, such as a money market fund or bank savings account.* As your savings increase, so can your returns. So be sure to capitalize on the earnings potential by exploring interest rates before you open an account.

Next, consider investing some of your emergency savings in an accessible, broadly diversified mutual fund or ETF (exchange-traded fund) with minimal tax consequences to help keep up with inflation and maximize your long-term growth potential. These supplemental savings could come in handy if you ever need to make up for an income gap.

Since certain professions and industries are more susceptible than others to unsteady work and layoffs, think about your personal risk of losing your job or experiencing a break in your income. If the risk is low and you have a decent cushion set aside in cash, it may make sense to invest some of your emergency savings. If the risk is high, perhaps an all-cash reserve is the better option for you.

Avoid taking on debt to cover an emergency.

Stay focused on building up your emergency reserve. A strong savings momentum can keep you from having to turn to borrowing, which not only increases your debt but can also jeopardize your relationships and long-term goals. That's why it's best to avoid these options if you can:

Credit cards. Interest rates on credit cards can be sky-high and you can expect to pay fees for any late payments. Your credit score could also suffer if you're unable to make payments on time, which can impact your ability to get more attractive borrowing rates on auto loans, mortgages, or home equity loans.
Loans from family or friends. Money can have a funny way of coming between family and friends, even when both the borrower and lender have good intentions. When you borrow from loved ones, your financial concerns can end up placing a financial burden on them too.
Retirement plan loans or withdrawals.** Using your retirement savings can hurt you more than you might think. When you take a distribution through a loan or withdrawal, you can miss out on years of compounding, which can decrease your chances of meeting your retirement goal. For example, a $10,000 withdrawal may seem like a small drop in the bucket, but over the course of 30 years, it could impact your bottom line by more than $50,000.

The cost of taking a $10,000 retirement withdrawal

Read chart description

This hypothetical example assumes that you miss out on 30 years of compounding at an annual 6% return. It doesn't represent any particular investment nor does it account for inflation, and the rate is not guaranteed.

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*While bank savings accounts and money market funds can both offer high liquidity and provide additional income in the form of interest and dividends, they come with material differences that should be considered before investing. For example, savings accounts may offer overdraft protection, ATM access (immediate access to your money), and other convenience features, whereas money markets may offer a more competitive yield in exchange for a very low level of risk.

**When taking withdrawals from a tax-deferred plan before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.

All investing is subject to risk, including the possible loss of the money you invest.

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