Emergency Funds: Everything You Need to Know
Unpredictability is a fact of life. We can plan all we want, but sometimes, it seems the universe wants to throw a wrench into our plans.
In the personal financial realm, the emergency fund is the tool of the trade for dealing with unpredictability.
But even something seemingly as simple as an emergency fund has plenty of contradicting information surrounding it.
What it is, what to use it for, how much you should save…
Everyone’s got their opinions on these and other emergency fund matters. With so much fragmented and conflicting info coming at you at once, you won’t know where to start.
In light of this, we’ve put everything you need to know about emergency funds into a guide for you. No longer do you have to scour the internet for scraps of information regarding emergency funds; read the full guide below!
What is an Emergency Fund?
An emergency fund is a chunk of money set aside (typically in a savings account) in case of large, unexpected expenses (read: emergencies). It acts as a safety net in case of financial crisis.
Typical emergency fund events include
- Car accidents
- Large, sudden medical bills
- Job loss
There are many more, but we’ll cover those later.
Why Should You Build an Emergency Fund?
Setting aside money into an account that you hopefully won’t ever have to use isn’t fun; you’d rather spend that money or invest it somewhere else, right?
In reality, failing to build an emergency fund can have disastrous consequences not just for your money, but for the other parts of your life.
Protect Your Assets
When emergency strikes, you’ll have to pay for it somehow. If you don’t have an emergency fund, you might have to sell several assets to cover the emergency. This could include possessions, investments, or any other valuables you may have.
With no emergency fund nor any assets, you’ll have only one other option (aside from asking family for a bailout): debt.
Given that emergencies are costly, you could end up with thousands of dollars in debt, instantly wiping away years of dedicated frugality and financial discipline.
Keep Other Parts of Your Life Running Smoothly
In a financial crunch, you have to cut off all expenses but the barebones. However, if you have enough money in your emergency fund to cover the emergency, you won’t have to drastically alter your life to stay afloat.
For example, you total your car by hitting another car, but fortunately, both of you get out with just minor scrapes.
Without an emergency fund, you’d have to scramble for money in any way possible, seriously disrupting your life.
But with the fund, you could cover the costs without putting your life on hold, as long as you work on replenishing the fund.
That being said, you should still look for ways to cut back on expenses and save more money after using your emergency fund.
Peace of Mind
Lastly, there’re few better feelings than having money in the bank. Something about being able to live for several months without a single dollar of income really eases the body and mind.
How Large Should Your Emergency Fund Be?
Recommendations vary, in general, your emergency fund should be able to cover about 3-6 months of your living expenses.
If you have no dependents, you’re likely safe with 3 months of living expenses for yourself. However, if you have a spouse and children, aim for the 6 months of expenses.
Yes, this measurement is a relative measurement, but more dependents means a statistically higher chance of an emergency.
Thus, you’ll want extra financial cushion to compensate.
When in doubt, err on the side of caution. Put a little more in than you think you need if unsure.
In terms of emergencies, living expenses are everything you absolutely need to survive or are required to pay. That includes food, housing, health insurance, utilities, and similar expenses.
No, things like gym memberships and Netflix subscriptions don’t count. You don’t have to cancel these right away during emergencies if your emergency fund is flush with cash (although we recommend doing so because you can purchase them again later), but don’t count them among your living expenses.
What If I Can’t Build a Sufficient Emergency Fund?
When you’re living paycheck-to-paycheck or you’re drowning in debt, saving any money is tough, let alone saving that money in an account you’ll rarely use.
In this case, some is better than none. Try to eek out at least 1 month of expenses as a buffer. Once you improve your financial situation a bit, build it up to the 3-6 month amount.
When to Use Your Emergency Fund: Emergencies vs. Non-Emergencies
Obviously, you should only use your emergency fund in emergencies. But what constitutes an emergency? And what should you NOT spend your emergency fund on?
Plus, some expenses toe the line between emergency and non-emergency. How do you determine if they’re a valid emergency expense?
Let’s start with a few things you should NOT use your emergency fund for.
- One-off or infrequent expenses – Whether it’s additional income taxes, property taxes, annual subscription fees, car registration renewal, or something else. Prepare for these ahead of time.
- Occasional expenses you can predict – Major car maintenance, house upkeep, holiday shopping, and other large expenses you know are coming. Save for those separately.
- Leisure activities – Obvious enough. Never touch your emergency fund when it comes to travel (unless you’re stranded and need it to get home or it’s for a family emergency), dining out, a new TV purchase, etc.
Alright, now time for some valid uses of your emergency fund.
- Car accident – To pay your deductible, as well as anything else you might owe in the complex insurance claims process.
- Job loss – Your emergency fund can keep you afloat or supplement unemployment benefits if you’re fired or laid off. However, if you have a spouse, rely on their income and only use your emergency fund if you’re still coming up short. If you both lose your jobs, then your emergency fund is your last line of defense.
- Large, unexpected medical bills – Maybe your insurance company refuses to pay part or all of a medical bill, or perhaps you get a bill that’s simply too expensive. Your emergency fund will come in handy.
- Certain travel – The only valid times to use your emergency fund during travel is if you’re stranded somewhere and out of cash, or if you have to travel for a family emergency.
- Natural disaster – If a storm damages your house, your emergency fund can tide you over while your home is fixed up.
Where Should I Put My Emergency Fund?
The best place to store your emergency fund is a high-yield online savings account, as it can earn plenty of interest. A second good option would be a money market account.
This interest not only matches inflation often (which has hovered around 1.6% – 1.8% in 2019), but it sometimes beats it. Those interest earnings can slightly speed up your efforts to hit your goal amount. What you do with that interest after you reach your goal is up to you, but we’ll share some ideas later.
For now, here are some excellent places to put your emergency fund so it works for you while it waits to be used.
CIT bank (not to be confused with Citibank) has a fee-free, high-yield savings account with a 1.55% APY. It’s very easy to open when compared to other banks; within minutes, you could have your emergency fund account ready and waiting for your emergency fund.
All you need is a $100 opening deposit to get started.
Discover’s got a 1.85% APY on it’s high-yield savings account, but where it really shines is its customer service. They also have a great mobile app on the App Store and Google Play store, both versions containing tons of raving reviews.
Discover has comparatively little fees, too. They don’t charge monthly maintenance fees, stop payment fees, NSF fees, or excessive withdrawal fees of any sort. Not a huge worry for your emergency fund in the first place, but it never hurts to know your money isn’t at risk.
Go for Discover if you’re willing to take an interest rate hit in exchange for simplicity and customer service.
How to Build Your Emergency Fund
Now, you’re armed with the knowledge on why you need an emergency fund, when and how to use it, and where to store it.
But how exactly can you build an emergency fund as efficiently as possible? Many people struggle to do so either out of financial strain or because it’s psychologically difficult to move hard-earned cash to a savings account that might never be touched.
Here are some tips for building your emergency fund no matter your situation.
Budgeting is important to determining your emergency fund amount. Using your budget, you can see exactly what your living expenses are for one month. Multiple that out by however many months (3-6) you need, and that’s your emergency fund savings goal.
The budget will also help you with tracking and cutting expenses…
Take a look at your budget and cut some expenses. You’ll have more room here than someone cutting expenses out of necessity because your expense cuts will only be temporary.
For example, you can easily get rid of streaming services for a few months to build your emergency fund. As a bonus, said streaming service might even offer you a free trial to reacquire you as a customer.
In addition, you may discover you can live without certain expenses once you cut them. That’ll free up money for goals beyond your emergency fund.
Start a Side Hustle
No need to launch a full-blown business. Freelance on the side, drive for Uber or Lyft, deliver for Postmates or Doordash, deliver groceries for Shipt or Instacart, get a 2nd job, etc. Direct your earnings to your emergency fund.
Use a Separate Account
This should be obvious, but too many people mingle their emergency cash with their normal savings or worse, their checking. Doing this makes tracking your fund hard; plus, your mind will find ways to rationalize little purchases here and there.
If it’s in your checking account, it won’t even have the opportunity to earn interest.
Put Savings on Autopilot
Set up weekly, semi-monthly, or monthly automatic transfers to your emergency fund. By doing this, you won’t have to think about moving your money over, and you’ll eliminate the temptation of spending money intended for your emergency fund.
Even better, add your emergency fund bank account to your direct deposit. Have a small portion of each paycheck go directly to that account until it’s full.
The moment you remedy the emergency situation that warranted emergency fund use, you should work on replenishing it. Set up your automatic transfer again. In addition, if you have a savings account for another savings goal, you could simply move some cash over to instantly restore the fund.
It may put your other goals on hold for a bit, but it’s a small price to pay for a safety net.
What About Interest?
The interest you earn on your emergency fund can be used a couple ways. If you’re confident you won’t need to rely on your fund anytime soon, you can use the interest earnings to further progress towards savings goals, invest, or spend it on yourself.
Alternatively, you can let it all sit in your emergency fund to make replenishing the fund easier when you use it.
We recommend both: put away enough to cover your expenses, leave some interest in to provide you some financial cushion, THEN take interest in excess of that amount and use it how you want to.
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