What Inflation Means for Emergency Funds

Like many other Americans, I’ve watched gas prices at the station by me creep up, and my grocery bill is running higher even though my family’s weeknight dinners haven’t changed. My spending habits aren’t the reason my wallet is lighter—inflation is. 

I can look for sales on my weekly shopping run, but my emergency fund won’t automatically respond to changes in the economy. Giving our emergency savings some extra attention matters when inflation is high. 

Here’s what you need to know about what inflation means for your emergency fund.

How Inflation Affects Emergency Fund Savings

Inflation affects the purchasing power of your money. As prices increase across the board, a dollar doesn’t stretch as far. Some inflation is good, because it shows economic strength and helps avoid a different economic problem of deflation. But when inflation soars too high, it can make it difficult for people to afford things they need, inflating the cost of college among other things.

Excess inflation, and the actions that the Federal Reserve takes to halt it, can push the economy toward a recession. That can make everything more challenging, from feeding your family to protecting your emergency fund against a market crash, to saving for college in the middle of a downturn.

Many policymakers say the inflation rate should be around 2 percent for a healthy economy. From May 2021 to May 2022, the Consumer Price Index rose 8.6 percent. Some financial experts and consumers are concerned that this historically high increase shows an unhealthy level of inflation.

What this means for any emergency fund savings you have right now is that, essentially, you don’t have as much saved as you thought you did. The purchasing power of your savings is impacted by the higher inflation rate, so it’s important to reevaluate how much your family needs to feel prepared.

How Federal Interest Rates Affect Emergency Funds

The Federal Reserve (or “the Fed,” if we’re keeping it casual) is the central banking system of the United States. It was created to implement more central control over the economy and help avoid or alleviate financial crises.

When the economy changes, the Fed can act by increasing or decreasing minimum interest rates. Credit card companies, banks, mortgage lenders and other financial institutions typically set their interest rates based on the direction of the Fed’s benchmark. 

The idea behind raising interest rates is that making it more expensive to borrow money will nudge employers and consumers to slow their spending. This can help keep the economy from racing toward unhealthy, hyperinflation territory. One benefit of higher interest is that if your emergency fund is in an interest-earning account, you’re earning more on your savings. This helps mitigate some of the eroding effect inflation has on your savings.

Admittedly, it’s basically impossible to find a bank that will offer a savings account with an 8.6 percent interest rate to match current inflation. As of the summer of 2022, most banks don’t offer much more than 1 percent interest. But if interest rates from the Fed continue to go higher, it could be a good time to investigate your high-yield savings account options. 

If you have any extra funds to save in a certificate of deposit (CD), these accounts tend to offer higher interest options than many normal savings accounts. Note that CDs set restrictions on when you can withdraw money, so consider talking with a financial advisor about the best strategy to divide your savings across accounts.

How Much Do I Need in an Emergency Fund?

The first step to feeling secure about your emergency fund is having a clear idea of how much should be in the account. 

Some guides to building healthy finances recommend $1,000 as a starting emergency fund target. This is a great first step, and $1,000 will certainly help toward covering unexpected expenses. But stopping once you reach that benchmark isn’t wise, especially in periods of higher inflation or economic uncertainty. 

A fully-funded long-term emergency fund savings goal should be three to six months’ worth of living expenses, according to many financial experts. You want your savings to protect your family against major events like job loss, in addition to incidental unplanned expenses like a car repair. 

In our current economic landscape, aiming for closer to the six-month figure may be a good idea, especially since inflation could make your three-month savings go less far than before.

Steps to Protect Your Savings

Higher inflation and worries about a potential recession can leave you feeling concerned about your finances. While you can’t control the economy, there are steps you can take to help your family stay as secure as possible:

• Keep saving: Saving for a rainy day can feel harder when grocery prices and other staple budget needs are rising. You’d rely on your savings to protect your family against emergencies, though, so it’s important to keep putting as much money away as you can, to help your savings grow with inflation.

• Review your budget: Now might be a good time to adjust your spending habits to counter the effects of inflation on your overall household spending. If you can find a cheaper store in your area for basic staples, that may help your budget (and your emergency savings) go farther.

• Check your investment mix: Talk to a trusted financial advisor about money you’ve invested in stocks, bonds or mutual funds. A financial professional can talk you through how changes in the economy affect the market and build a strategy with you to protect your investments.

• Find free alternatives to budget items: If money’s tight, you may be able to find no-spend options to meet certain needs. For example, a group of parents may be interested in a clothing swap of gently-used items that could fit children in other families. You may also be able to swap babysitting evenings with another family to have a cheaper date night or a quiet night in.

• Check your overall financial health: If you’re able, paying off credit card debt can save you on interest payments and free more money to direct to your savings or daily expenses. Make sure you feel comfortable with your life insurance or disability insurance coverage, so that in a true worst-case situation your family has the financial protection they need. (Here's how inflation impacts your life insurance policy.)

If you’re worried about inflation, it’s smart to start by reviewing your emergency savings. A healthy emergency fund can go a long way toward helping your family weather a difficult economic season. And if you find yourself in a bind, familiarize yourself with the better and worse options for getting emergency cash.

Even with rising prices at the pump or the check-out aisle, it’s all the more worthwhile to save what you can and protect your family against the effects of inflation.