An emergency fund can mean different things to different people. Essentially though, it is money that you can access very quickly without any complicated steps. The amount that you should have in your emergency fund, varies by individual. However, for peace of mind, you should consider having a simple emergency fund set up before you initiate your long-term investing plan.
Nobody likes thinking about emergencies. It is said, however, that people who anticipate emergencies, and make a mental plan for what they will do in such a scenario, are much more likely to have a favorable outcome. It’s why we practice fire drills at school…
Similarly, having that emergency fund in place will you give you peace of mind knowing that you have easy access to your money, without jumping through hoops, should the need arise.
To me, that is worth it. But there are plenty of considerations that vary by individual as well. This has the Wh’s written all over it. Who, What, Where, When, Why (and How/How Much)? Let’s take a look at all of these (except for “Who”. That’s hopefully all of us.) so you can make an informed decision on what works best for you.
First, let’s get on the same page on the basics for what an emergency fund is and why you might want to have one.
What is an Emergency Fund and Why do I need one?
An emergency fund, in my mind, is any money that you have easy access to AND you won’t touch unless a situation you deem emergent arises.
People can need emergency funding for a variety of reasons. Essentially though, it’s for a significant and unexpected expense that arises. Should this expense present, you have these emergency funds so that you don’t have to scramble or take on high interest debt to cover it.
Where you keep your emergency funds depends on what works for you.
For me, I can’t necessarily keep my emergency funds in my checking account. In theory, I could dip below what my designated threshold (we’ll definitely discuss this), a little too easily. In fact, I could do this without even knowing it. Then, should the need arise, the money wouldn’t be there.
Keeping your emergency fund in a place where you can’t accidentally access it, is definitely part of the equation.
So is easy access.
If the need arises, you don’t want to be selling off invested funds and waiting many business days to have access to it and more business days for it to transfer to your bank. That’s not immediately helpful (though eventually this can factor into the equation as well. We’ll discuss this later as well).
So, like I said, we need the emergency fund to be accessed easily, AND it should probably be separate from the account we have for everyday expenses.
Next, let’s look into where we might want to store your emergency funds.
Where Should I Keep my Emergency Fund?
Personally, I think a separate savings account at your bank is the best place to store an emergency fund.
All of my day-to-day spending and credit card bills come out of my checking account. So, if I keep my emergency fund in a separate savings account, I can’t unknowingly dip into it.
This is that extra layer of protection (from myself!) that gives me peace of mind.
Additionally, because I am so very frightened of overdraft fees and the like, I always like to keep a cushion in my checking account as well. This, in essence, is a little extra emergency funding that I can access very easily.
If this line of thinking appeals to you, then go to your local bank and open a separate savings account to store your emergency fund.
Want bonus points? (Don’t we all?) Go shopping for a bank that has the highest interest rates. That way, your emergency fund can actually grow a little while it is sitting there.
Typically, a savings account will be the one that has higher interest rates than a checking account so that seems like the best candidate for storing your emergency fund.
Personally, because savings rates were so low, I did not even bother. However, shopping around online, I did see a few that had rates at .5% (half). If there is a branch in your area that has such an account then it’s probably worth it.
I always like the idea that it’s growing, even a little, while I do absolutely nothing to it.
Do you have a Need for Speed?
In my mind, I can’t envision too many interactions where I would need absolutely instant access to my money. The reality is, I have a cushion in my checking account, AND I have credit cards (that I pay off in full each month) that give me points.
The problems arise when unexpected expenses that can’t be put off arise and you don’t have the money available to cover it.
This means you end up charging it, and because you don’t have the funds to pay it off, the credit card company starts charging those deadly APR’s (Annual Percentage Rates) in the 19 – 25% range.
This is where the emergency fund comes in. It helps you avoid that slippery slope of credit card debt.
When I invest, I’m accounting for 8% return on investment. This allows my money to double every 9 years.
If my credit card APR is 24% then that is 3 times the percentage yield of what I hope for in investing. This makes my debt double every 3 years. That hurts and we want to avoid that pain!
So, with the emergency fund in place we can charge the unexpected expense incurred and it gives us a whole month to allocate funds.
If you are still concerned about needing instant, instant access to your funds then open that separate account at a new bank and put whatever amount you deem necessary in the checking account. The rest of the emergency fund can go in savings.
Then, you have fast access to it but you also know that funds from that particular bank is ONLY to be used in the event of an emergent, unexpected expense.
Emergency Fund over Time
As you start saving and investing your money, the emergency fund becomes even less concerning. After your emergency fund is established, you may begin investing your extra savings.
Here’s a post on the very basic, easy to follow investing plan I use.
This newly invested money will go into a brokerage account (don’t worry about this now but essentially it’s an investing account for your money after it’s been taxed. It’s for the money you actually get in your paycheck). This means, you’ll have access to that money as well. It only takes 3 or so business days (I’m sure it varies place to place).
Three days is well short of the month you have once you charge something. So, if that expense arises, you can calmly make the necessary transfers to pay off that credit card in full.
The same is true for a Roth IRA as well by the way. I don’t ever want to touch my Roth IRA (a retirement fund for after tax money that does NOT get taxed when you extract it later (presumably after it has grown considerably)). You CAN take out the money you have put into a Roth IRA without penalty. Read that last sentence carefully, because it’s only for the money you have put in and NOT for the interest you have accumulated. Nevertheless, you can access it if the need arises without penalty as well.
So, as you can see, as you begin saving beyond your emergency fund, you have more options and each unexpected expense becomes less dire.
Why Even Bother with an Emergency Fund?
After reading that preceding section you may be wondering, if I have so many options, then why even bother with the emergency fund? Why not just start investing and growing my money right away and have it double as an emergency fund?
First off, I like how you are thinking. Now you are thinking long term and how you want to grow that money you’ve worked so hard to save. But there’s a “but” coming here…
BUT, there are a few reasons this line of thinking isn’t as effective as a starting strategy.
The reasons are taxes, fees, maintenance, and mindset.
If you invest that money and it starts growing, you might be feeling pretty good about it. If you then have to take it out there will be a few things working against you.
First off, if you have it in the account less than a year than any gains you have accumulated from your invested will be taxed as income ( called short term capital gains, but don’t worry about it now).
Some brokerage firms may also charge a transaction fee.
I’ve never done this so I don’t know, but if you spend all the money you have in that account you may have to close it out as well. That could be high maintenance and may prevent you from reopening it again in the future. We don’t want that.
But most importantly, I don’t like the mindset of it all. I don’t want to have you lose all that momentum. Additionally, we want to be thinking long term. So, when you put money in a Roth or brokerage account we want to be thinking that this is money I am setting aside for my future self.
In my mind, for those reasons (taxes, fees, maintenance and momentum) it’s very much worth it to establish your emergency fund before you begin investing.
But fear not, you’ll be growing and investing your money in no time! If you’re like me, you just want to get things started right away. I totally get that! But because we’re thinking long term, what’s 4-6 months in the scheme of many decades?
It’s a blip on the radar, that’s all.
Once you access a few money saving tips, and drastically improve your savings rate, you are going to have that emergency fund set up and you’ll be adding to your investments in no time.
How much should I have in my Emergency Fund?
This is where we get into that nebulous area of “it depends”. I hate those answers, but they exist for a reason I suppose…
Nevertheless, I’m going to toss out a number at the end and try to justify it. First, a little background.
According to this article on CNBC, ONLY 41% of Americans would be able to cover a $1,000 emergency with their savings.
But, the article goes on to say that the average cost of such an emergency is $3,500.
Both of those statistics can be very problematic if you were to incur an unexpected expense. If you are unable to pay it off, then you will probably end up paying much more over time due to credit card expenses. We want to have our funds in place so we don’t get bogged down in expensive credit card debt.
Continuing on, if you do a quick Google search, most sites recommend anywhere from 3 – 8 months worth of expenses.
The good news is, because you have drastically improved your savings rate, you now “need” less each month and that brings the amount required for your emergency fund down as well.
My nebulous version of this answer to the question “How much do I need in my emergency fund?” is; Whatever gives you peace of mind.
If you think your amount is too low and it causes you stress, then add to it. Conversely, if you are not as concerned, then maybe it’s okay where it is.
But now I’m going to throw out a concrete number here. I do this in case you are a “doomsday thinker” and you feel like you can NEVER have enough in your emergency fund. I also want to make sure you’re not “too cool for school” and think $100 bucks should get it done.
How does $6,000 – $10,000 sound for you as an individual? If you share expenses with a partner then you can double that.
Here’s my logic: If I get into a situation where I just dipped into my emergency fund, and I have no source of income, then I’m immediately going into preservation mode. Bye-bye to any extraneous spending. Adios gourmet coffee and Netflix. So long occasional restaurants and wardrobe upgrades.
I will only pay for housing, food, utilities, gasoline for necessary transportation, phone/internet (this would be a last resort cut). You get the idea.
With that mindset, and no income, I could get 6 months out of $6,000. But it wouldn’t be pretty. And remember, that’s just for me. My wife would have similar expenses as well. Double that figure if you share expenses.
But realistically, I also think I’m going to be earning money in that time as well. I’m confident I could bolster my income and extend that emergency window.
Maybe you don’t feel as confident, or you don’t want to kick it into such a drastic savings mode. In that case, your number might be higher.
Ultimately, it comes down to personal preference, but that $6,000 – $10,000 range gets you in the ballpark (in my humble, non-professional, opinion).
Look at the expenses that you are unwilling/unable to part with and use that to devise your own emergency fund number. Going above or below the range is fine as long as you are intentional and can justify it.
Then, once you have your number, go about getting it so you can then turn your energies towards building your long term wealth as well.
Family and Other Considerations
I was raised in a family where we openly talk about finances. I’m thankful for this but I believe I’m in the minority on this one. In general, I would say it’s still generally taboo to discuss finances. I disagree that it should be, but it’s not my call either.
However, if you do feel open to having these conversations with trusted friends and family, then I think it’s a worthwhile idea. It may give you a little peace of mind and/or clarity on how much you need for your own emergency fund.
Basically, you want to know, in the event of an unexpected expense, how much can you expect from this person.
You should also have a conversation around what constitutes an “emergency”. If my brother asked me for $500 because he “needs” to get the newest gaming system, I’d tell him to get lost. Make it clear, what would and would not constitute an emergency.
What I don’t think you should do is assume you will be helped. I think a lot of people get into trouble by assuming their friends or family will help them when need arises.
Then, if they don’t get the help they were counting on, a rift can form. Feelings of anger, disappointment and betrayal can arise. We want to avoid that.
And let’s be honest. People are weird about money. Why should our friends and family be any different?
Here’s how I might go about starting a conversation.
Example conversation with Friends or Family
So, how about this for a conversation starter?
You: “Hey (friend or family member). I have a somewhat serious question to ask you but I want you to know that, whatever you answer is okay.
Them: OK. (Right now they are intrigued). “What are you going to say?” they wonder.
You: It’s about money.
Them: “Oh no,” they think. “They’re going to ask me for money! I knew I shouldn’t have asked them if they needed anything!”.
You: “Don’t worry, I don’t need any money from you!” you blurt out.
Them: “Phew!” (Now they are primed for the conversation.)
You: I’m starting to think long term and I want to set up an emergency fund. Again, whatever you say is fine. I just want to make sure I have all the information before I start. Basically, I want to know, should an emergent unexpected expense arise, would you be willing to temporarily help me out so I could avoid getting into major debt? And if so, I would want to know how much I can reasonably expect from you, with the obvious idea that I would eventually pay it back?”
“Remember,” you continue, ” I don’t have a need right now and zero is an acceptable answer. AND as I start saving more and more in my own fund, there is less of a chance I’ll need help from you. However, I just want to factor in your answer when I find an emergency fund number that works for me…”
That’s the general idea. Was that clunky? I tend to be clunky. But ultimately you want to find out if they will help you out and for how much.
So, frame the conversation any way you want, but if you are going to rely on others as part (not all) of your emergency fund, then you should have the facts straight so as to avoid duress should your need arise.
Also, it’s important to keep in mind that it’s extremely difficult to know how much available money people have by looking at them. Some people like to have all the best stuff but they are in a ton of debt. Others, can be covert millionaires that drive around in a 2004 Corolla and haven’t bought a new article of clothing in 20 years (that’s my own personal goal). The point is, they may not be able to help you and you want to know that before the storm hits.
In my humble opinion, IF you are NOT willing to have that conversation, then I think you have to assume that you will NOT get assistance and plan accordingly.
Also, even if they say they will give you $1,000,000 I think you should still establish your emergency fund(it just might be slighly less). If you thought that conversation was clunky it’ll only be worse when you have to actually ask. And, as much as we don’t like to think about it, other things can come up and we don’t want to put all of our eggs in their basket.
Using your Emergency Fund
If you do end up accessing your emergency fund, make sure that you refill it once you start getting traction again.
First, if you ended up having to use credit cards, pay those down as quickly as possible.
Then, if you had to borrow, pay that back next. This will show, if it comes up again, that you are good for it.
Next, refuel your emergency fund. On this step, you can also reassess what a good number is for you and your peace of mind.
Finally, once you have retooled, you can begin investing again.
In Summary
Nobody likes to think about needing emergency funds, but taking the time to establish one can dramatically reduce stress should the need arise.
It can also save you lots of money as it prevents you from incurring those massive credit card expenses.
If you haven’t already, it’s probably a worthwhile venture to sit down and come up with a plan for your emergency fund. How much you put in it, and where you store it, are personal preferences and up to you. Hopefully this post gave some helpful guidelines for you to consider though.
Finally, if a trusted friend or family member is to be part of your emergency plan, I strongly recommend an explicit conversation. Find a way to get on the same page about what an emergency is and how much money you could rely on should the need arise.
Then, once you have factored in all of these considerations, start saving and working towards your goal.
The emergency fund gives you peace of mind that you will be taken care of should an unexpected expense present itself. That, to me, is a worthwhile investment!
Thank you for reading. I welcome your thoughts and comments below. Do you have an emergency fund number that works for you? Have you had any of these conversations with friends or family that we can learn from? If it’s that, or anything else, then I want to hear about it. And as always, if you prefer, feel free to reach out and contact me at any time.
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