Emergency Fund Complete Guide: How Much & Where

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You may know what an emergency fund is, but are you sure about where to put it, how much to put in it and when to spend it? And why do so many people struggle to get started?

In this article, I’ll answer all your emergency fund questions and give you money expert Clark Howard’s tips and advice.


Table of Contents


What Is an Emergency Fund?

An emergency fund is money you set aside, in an accessible place, to pay for unexpected expenses like car repairs or medical bills.

Emergency funds also can protect you if you lose your job. Clark sometimes calls them rainy day funds or “oops” funds.

“If you don’t have savings, then you’re not prepared for the ‘oops’ in life,” Clark says. “Because ‘oops’ happen — all different types and sizes — and a lot of times we’re not in a position to deal with them.”

We’re all certain to experience unexpected financial surprises at some point. They can be stressful. Worse, many Americans have to pay for them with high-interest credit cards or by borrowing money.


How Much Money Do I Need in My Emergency Fund?

How much emergency fund money do you need?

How much money should you keep in an emergency fund? It’s a fair question, but if you’re just getting started as a saver, focusing on the number may not be helpful.

Clark says that your first priority as a saver is to start somewhere. If you don’t have any savings, take $10 from your next paycheck and put it into a savings account. Don’t feel pressured to meet a quota or a timeline. Just get in the habit of contributing to your savings account. Then increase the amount you’re contributing over time.

“It’s all about building habits, whether it’s with your health or your wallet, that you do it one step at a time,” Clark says. “And then, when you’re in that habit, you really can move toward the goals that are really going to change your financial future.”

Clark likes automated savings. He recommends setting up an automatic transfer into the account that holds your emergency fund every paycheck or once a month. It’s better to save first rather than waiting to see if you have any money left over.

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If you’ve already set up automated transfers to your emergency fund and you want to quantify your goal, figure out the total of your household’s monthly expenses. It’s great if you can eventually store six months’ worth of expenses in an account that’s easily accessible.


Where Should I Put My Emergency Fund?

Where to put your emergency fund? You have plenty of options.

Quick answer: in a savings account at an online bank or a credit union.

Savings Account: Online Bank or Credit Union

It’s important to keep your emergency fund and checking account separate. Clark even suggests keeping them at separate financial institutions.

The best online savings accounts and credit unions pay more interest than traditional brick-and-mortar banks. Some institutions even offer penalty-free Certificates of Deposit (CDs) that tie up your money for only a few days after you deposit it.

Savings accounts give you the quickest access to your money: You can usually withdraw cash from an ATM or transfer funds into your checking account. That sort of immediate access is helpful in case of an emergency. Savings accounts are also insured by the FDIC, making them a very safe place to put your money.

However, interest rates are sitting at historic lows. As of February 2021, it was challenging to find a savings account with a rate above 0.50% APY. You’ll also have to pay taxes if you earn more than $10 in interest in a given year. Considering that inflation tends to hover between 1% and 3% annually in the United States, the money in your savings account in 2021 may actually be losing value over time.

Clark says, because interest rates are so incredibly low right now, you may want to consider putting your emergency fund into a Roth IRA or a short-term bond index fund.

Roth IRAs as an Emergency Fund Option

Roth IRAs are retirement accounts that allow you to withdraw 100% of your contributions (the money you deposited into your account but not your earnings) without any sort of tax penalty, regardless of your age.

Emergency funds, or rainy day funds, are earmarked for unforeseen events. These funds need to be readily accessible, but you should use them judiciously (more on that later).

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If you don’t have to rely on your emergency fund very often, allowing it to earn money for your retirement in a Roth IRA while still being available to you is one option.

Short-Term Bond Index Funds as an Emergency Fund Option

If you’re interested in overcoming the historically low interest rates, you could also consider holding your emergency fund in a short-term bond index fund. Those are low-risk investments that can generate a much greater return than you’ll get from a savings account.

“That’s a strategy that I do myself, knowing that you’re earning effectively nearly zero in an online savings account [right now]. I mean, just not much money at all,” Clark says.

“You do have the chance, even in a short-term bond fund, that you could lose money. But it is a relatively low risk, low enough that it is the same strategy that I use.”

Clark recommends Vanguard for short-term bond index funds because of their low-cost structure. He says that’s key to maximizing your return on a bond fund.

Using Money Market Funds as a Tax Strategy

As I mentioned, if you earn $10 or more in interest from a savings account, you must pay taxes on your earnings.

Currently, 0.50% APY is a competitive interest rate for savings accounts. If you have $10,000 in a savings account, you’d earn $50 in interest in one year. That’s not a lot, but it’s enough to require paying taxes. If you’re a high earner with a lot of monthly expenses and a high tax bracket, you may want to consider a municipal money market fund, which is tax free.

“Because if you are a high-income earner, you could be paying federal tax as high as 37%,” Clark says. “And if you go in a municipal money market fund, you won’t be paying any of that federal tax on the money you have in that savings. And it’s available to you just as readily as the money you have in an online savings account or at a credit union.”

Money market funds are available for immediate withdrawal, so they’re more liquid than, say, an investment in a stock.

Bad Ideas for Emergency Funds

There are several good options in terms of where you should put your “oops” fund. But speaking of “oops,” it’s also important to avoid these four mistakes. Try not to:

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  • Rely on credit cards to pay for emergencies. Credit cards are notorious for charging lots of interest. You really don’t want credit card companies reaching into your wallet to collect interest every time you face an unexpected expense.
  • Keep your emergency fund at a big bank. Clark has talked extensively about the ways in which he thinks America’s biggest banks mistreat customers. One of those ways is by paying puny interest rates.
  • Keep it all under your mattress. If you think inflation will take a bite out of the buying power of your emergency fund in a savings account, imagine what it will do if you’re earning no interest at all. Not to mention that it’s not as safe to keep your cash at home as it is to keep it in an account.
  • Invest it all in the stock market. You don’t want to take too many risks with the money you’re setting aside for unforeseen financial obligations. Also, it’s important that your funds be fairly accessible. It may take several days for you to sell a stock and transfer the money into your bank account.

When Should I Spend My Emergency Fund?

Whether you’re thinking about starting an emergency fund or yours already holds six months’ worth of expenses, you may be wondering when it’s appropriate to spend the money.

Just in case it needs mentioning, “oops” funds, as Clark sometimes calls them, aren’t there to pay for your family vacation, buy a motorcycle or help you eat at your favorite steakhouse once a week. But if you need to dip into your emergency fund for any unexpected expense, even as you’re still building the fund, don’t worry. That’s why it’s there!

What happens if you’ve socked away six months of expenses in an emergency fund, you have some money in your checking account and you face an unexpected cost like car repairs?

“Usually somebody doesn’t have cash and an emergency fund. But if you have cash in your checking account, you go there first,” Clark says. “If you can afford to pay for that, you go there and you leave your rainy day account alone.”

Wondering what types of unexpected expenses happen frequently and how much they cost? Clark.com recently researched the prices of some common emergency expenses. Some examples include a cracked car windshield and water heater repairs.


Why Do So Many People Struggle To Build an Emergency Fund?

Even before COVID-19 started wreaking havoc with people’s lives, a large number of Americans didn’t have much in the way of savings. Many more of us are facing now ongoing financial challenges which are reflected in the latest statistics.

According to Bankrate’s most recent annual survey on financial security (January 2021), just 39% of Americans could cover an unexpected expense of $1,000 from savings. Not surprisingly, 35% of Americans say they have less emergency savings now than they did before the onset of the pandemic. And more than 20% of Americans don’t have a single dollar in savings — the highest percentage in the decade-long history of Bankrate’s annual survey.

Saving a significant amount of money is a long-term challenge for most people. Clark stresses that comparing where you are now to a daunting goal can be detrimental to your attitude toward saving. The important thing is that you start somewhere even it’s saving just a tiny amount. Time is on your side after that.

If you haven’t done so already, creating a budget is a great first step. For many people, saving even a little money can necessitate some thought and creativity. But the Clark.com team has some great resources if you need ideas on how to save some money regardless of your income:


Can an Emergency Fund Be Too Big?

Putting every extra dollar into your emergency fund indefinitely is a horrible idea. You’ll pay a big opportunity cost. Investing will get you a better long-term return on investment, which could make a huge impact on your ability to enjoy a financially successful retirement.

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You want to balance the need to have quick, accessible cash with the ability to make money with your money.

It’s OK to go beyond six months of expenses. There’s nothing wrong with a little extra cushion in your emergency fund. But don’t overdo it.

When Investing Becomes Better Than Saving

If you’ve already built an emergency fund and you’re following Clark’s step-by-step plan on saving and investing, you’re probably putting a chunk of your income into a retirement account such as a 401(k).

What happens if you lose your job or you run into a significant medical issue — especially if you’re too young to withdraw from a retirement account without paying a stiff penalty?

You may be tempted to overstock your emergency fund for this type of situation. But Clark advises against it.

“What I would do instead is once you’ve built up a sufficient cushion, open a regular investment account. And don’t do target date funds,” Clark says. “Build a portfolio of a total stock market index fund, a total international index fund and a bond index fund.”

You can build that simple kind of index fund portfolio at any of the three best investment companies, but Clark likes Vanguard for its low expense ratios.

You’ll pay income tax on any interest you earn from a savings account, whereas you’ll pay capital gains tax — usually at much more favorable rates — on realized gains from your index funds.

“If you’re in index funds, year by year, you may not generate any tax bill at all,” Clark says. “And then you have the added flexibility that the money doesn’t specifically have to be held ’til age 59 and a half, where a retirement account would have to wait ’til then.”


What Comes First: Paying Debt, Saving or Investing?

Clark Howard recommends paying off debt and saving at the same time.

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All this information about your emergency fund is great. But you may be wondering: What is my top priority: paying debt, saving or investing?

Paying off debt is a hugely important step to financial health. But Clark says you should start to save even if you still have debt outside of your mortgage.

“It’s important to have some amount of money in savings so that when the ‘oops’ happen — and ‘oops’ always happen — you have some money there so you’re not chasing your tail,” Clark says.

“I don’t want the mentality to be, ‘Uh-oh, our water heater broke. I don’t have $350. I’m going to pull out my credit card and pay the $350.’ I want that to come out of the savings. There’s not a perfect ratio of how much you put into each. But do both, not one or the other.”

Clark recommends saving before investing but doesn’t talk in absolutes about the amount of money you need in your emergency fund before you invest a single dollar.


Should I Keep Any Cash on Hand?

Money expert Clark Howard thinks it's a good idea to keep some emergency cash at home.

In the 1990s and 2000s, my family members talked a lot about having cash on hand in case of emergencies.

It seems like something you hear about much less often in 2021, as we live in an increasingly digital society. But what would happen if there were an emergency that affected our banking systems? Have we forgotten what used to be household common sense?

Clark says it’s still a great idea to hold at least three days of “walking around money” in cash.

“I have $400 in cash on hand. No one will find it if they come looking for it, but if I don’t have access to money otherwise, I know that I have that much,” Clark says. “$400 can cover a lot of things in the event that global banking systems are not available.”

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Final Thoughts

Building an emergency fund is just one aspect of creating a healthy financial life. But if you don’t have one, it sure can be stressful living paycheck to paycheck.

The other side of that: It can feel really satisfying to increase the amount you have in your emergency fund. It’s especially rewarding to save over time. Plus, when you’ve built your emergency fund, you’re ready to invest. That’s exciting.


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