Did you know that less than 40% of American households have more than $1,000 saved for an emergency according to recent studies? Most would have to rely on going into debt to cover basic car repairs, most do not even have $400 saved to cover any unexpected expenses. They are living on the edge and just one medical emergency away from bankruptcy. Thankfully with a little planning and intentionality you can steer clear from financial upheaval.
An emergency fund is what I like to refer to as the “S#!& HAPPENS FUND” and it is basically a stash of cash that you can easily access in the event of an emergency. It’s money put aside for that rainy day which will undoubtedly come for everyone at some point. It’s that safety net that allows you the chance to breathe when something goes wrong. It’s a security blanket in an insecure world.
Financial security has always been at the top of my priorities so having an emergency fund has helped ease any financial stress I’ve endured throughout the years. I started my emergency fund during college while I was working two jobs and going to school full-time. I always felt better having that cushion of money to count on just in case I needed it.
Some people call it their savings account but by defining it as an emergency fund it can help make sure that money stays there. Savings accounts typically are just accounts with extra money in them. A lot of people will pull money out of their savings accounts for purchases, “non-emergency” purchases that is.
An emergency fund really needs to be off-limits unless it is a true emergency. A new couch is not an emergency. A vacation is not an emergency. Having your transmission go out on your car is an emergency. A visit to the ER because you fell out of a tree rescuing a neighbors cat is an emergency. A busted pipe in your laundry room is an emergency. See the difference? Some things have to be taken care of immediately. You can save up for a vacation, it’s something you plan for, getting hit by a car is not.
There’s a variety of opinions out there about how much money you should have in your emergency fund. Ultimately you need to analyze your own financial situation and do what’s best for you. The common advice is to carry at least 3-12 months of expenses. If you don’t know how much your monthly expenses are then you need to start there. Determine how much money you spend each month including things like housing, transportation, food, utilities, car payments, loans, credit cards, all of your bills, etc. This number hopefully is smaller than how much money you bring home every month. If not, back up and find ways to cut expenses and payoff debt as fast as you can. You want to get your foundation solid and under control before going and building a big emergency fund. That doesn’t mean to not have any money saved for emergencies if you are at this point, it just means to have a smaller amount, like $500-$1000 saved until you get out of debt. You can read all about how we paid off over $76,000 in less than 2 years here.
Once you know what your monthly expenses are than you can determine how many months you should save. If you have a really stable secure job with a steady income then maybe you feel comfortable with just 3 months of expenses saved. If you have an irregular income and an unsteady job and income is volatile then having closer to a years worth of expenses might be better in that case. Typically most households will vary between the 3-6 months of expenses. This amount covers any job loss for a few months while you get back on your feet. It also covers most major car or home issues that may come up. For example, if your monthly expenses are $3000 then you will want to have anywhere from $9,000 to $18,000 in your emergency fund. Since I’m big on security we keep 6 months of expenses in our emergency fund, it helps me sleep better at night knowing we have that money readily available if we need it.
You will want to keep your emergency fund in a liquid account, meaning that you can easily access it if you need it quickly. A regular savings account would work to keep it in, a money market savings account is another option as it has a slightly higher interest rate but some require hefty minimum deposit amounts to open.
You could go one step further and optimize your earnings by opening up an online account through a bank like Synchrony, Barclays, or Ally where the interest rate is much better than the measly amount it would earn in a regular savings account (the average APY on these accounts today is 0.05%). This is where we prefer to keep our emergency fund, through Ally banking. They are able to offer high interest rates (currently at 1.85% as of the writing of this article) because they do not have brick and mortar locations with lots of operational costs so they are able to pass those savings onto you the customer. This can amount to quite a bit of extra cash for you. For example, if you had an emergency fund of $20,000 in a regular savings account at 0.05% you would earn about $10 a year compared to the same $20,000 in an account at Ally where you would earn $370 a year. It’s simple to open an online account and just as safe and secure as your normal bank. You can even set up direct transfers from your regular bank so if you need the money it can be available within a day or so.
You really do not want to keep your emergency fund in CD’s because you get penalized for the early withdrawal in case you need to pull it. You also don’t want to keep it in the stock market as it is too volatile and this emergency money is not intended to make you rich off the earnings, it’s just there to protect you. You definitely don’t want your emergency savings to be solely a credit card either, unless you are able to pay the balance in full at the end of the month then this is very dangerous as it can lead to very high interest rates and besides that being in debt is not the path to financial peace.
If you’re still struggling to pay off debt then focus on that first, come back to revisit the emergency fund once you’ve paid off all of your consumer debt. Then spend some time bulking up that emergency fund as fast as you can. If you’re saying to yourself how can I save 6 months of expenses when I can barely save $20 then it’s time to evaluate your spending habits, see what expenses you can cut, where are you spending money unnecessarily? Is the problem not on what you’re spending but rather on your income then think about how you can increase your income, maybe looking for a better job or picking up a second job temporarily will help you get there. Where there’s a will there’s a way.