How You Should Think About Emergency Funds

First of all, do you even need an emergency fund?

YES. You can call it whatever you like - a “Life Happens” fund, an “F* You” fund, an emergency fund, honestly whatever name floats your boat and makes you the most motivated, I am all for it. (Though just for clarity, I’m going to refer to it as an emergency fund in this post.)

What’s an emergency fund for (and what’s it not for)?

The emergency fund concept is all about having cash on hand and available to you so that if something happens in your life where you need more money to cover it than your general income/spending might allow, you have it. That way you don’t have to put the unexpected expense on a credit card or worse. While unexpected expenses are by definition unexpected, they are expected as a whole (you’re never going to not have anything unexpected happen to you your whole life!) and you can plan to mitigate them by having an emergency fund.

Now, “something happening in your life” is more about your car breaking down or about a medical emergency or job loss. It’s not for random online shopping, not for paying for the latest running shoes you want to buy, not for holiday plane tickets or anything else you can predict. It’s for unpredictable, unexpected expenses, and shouldn’t be touched except in those cases where you really, really need it (and you’ll know when it happens!).

How much should your emergency fund have?

Typically 4-6 months’ worth of expenses. Whether you’re on the 4 end or the 6 end depends on a few factors. Four months’ worth of expenses could be enough if you don’t have any dependents and you have multiple streams of income. Six months’ worth could be needed if you have people dependent on you or you rely on just one source of income. But you should also take your comfort level into account too. If you’re not comfortable with “just” four months of expenses and having six helps you sleep at night, then go for it.

To determine how much money these amounts are to you, multiply your monthly spending (including rent and any debt payments) by the number of months you would like to have. (If you don’t know how much your spending, go here for tips on how to sustainably track your spending.)

Set incremental goals

Of course, if you’re just starting out, don’t at all feel like you have to start with a six-month goal right off the bat! Huge far-off goals easily feel too unachievable. Start off by saving $1,000, then one month of spending, then two months’, etc.

Where to house your emergency fund -

Your emergency fund should be separate from your checking account. It’s much too easy to spend money if it’s too readily available to you!
You might as well earn some interest on this money since it will be just sitting there for you (and giving you that peace of mind!).

These two requirements above lead me to recommend that most clients keep their emergency fund money in a online high-yield savings account (you can check bankrate.com for the going interest rates) like Ally or Marcus. In a bank account like this, the money is still very accessible via a 2-3 day ACH transfer and is also covered by FDIC insurance, while still being separate from your day-to-day spending money.

Important note: Do not invest your emergency fund! If it’s invested, it’s not your emergency fund. Your emergency fund is not for maximizing returns, it is for helping you sleep at night.

A note if you’re paying down debt -

You still need an emergency fund! Even if you’re paying down high-interest rate debt, you should still work to save at least $1,000 in cash as a sort of bare-bones emergency fund until you’re done paying off that debt. If your debt is at a lower interest rate, then consider saving a larger emergency fund. The goal of saving any amount of emergency fund is to prevent yourself from going back into the debt cycle - there’s no guarantee that you won’t need emergency funds until you’re done paying off debt (and in fact, I’m sure you will), and when it does, you don’t want to have to put it on a credit card that you just worked so hard to pay off!

Need guidance on how to get your emergency fund set up or how to prioritize it with your other life goals? Schedule a free intro chat with me here!

Sarah GerberSeptember 8, 2020