This post may contain affiliate links. That means if you click and buy, I may receive a small commission (at zero cost to you). Please see my full disclosure policy for details.
I cannot remember a year when we leaned on our emergency fund more than we have this past 12 months.
- Broken water heater
- Multiple emergency car repairs
- Medical treatments
- Busted sewer pipe under the garage
I could keep going, but it’s depressing. The good news, though, is that we didn’t have to go into panic mode wondering how we were going to pay for all of these unexpected expenses because we planned ahead.
We had an emergency fund.
You’ve probably heard of emergency funds before or heard them mentioned in the news recently. With rising costs everywhere and economic strain worldwide, e-funds have become a popular topic among money experts and TV hosts as part of popular money management tips. For a good reason too — emergency funds work.
While it might seem like a straightforward topic, it’s one near and dear to our hearts.
A recent LendingClub report found that nearly 64% of Americans live paycheck to paycheck. That’s a huge number. And it doesn’t matter how much money you make. The same report revealed that 48% of individuals making $100,000 or more annually live paycheck to paycheck too.
Six figures don’t mean much if you spending all of it.
— Rahkim Sabree (@RahkimSabree) May 4, 2022
We need to get better at managing our money no matter our starting line, our current situation, or, how much money we earn.
And it all starts with an emergency fund.
What is an emergency fund?
An emergency fund is a fund set aside for emergency expenses that fall outside of your regular spending. It’s an absolute building block of any family’s money management plan and one of the first things you need to establish before pursuing other financial goals.
Unexpected expenses have a habit of ruining even the best-planned monthly budget (and beyond), often putting you in a hole short or long term. Having an emergency fund keeps you from wrecking your monthly budget. With an emergency fund set up, you can pull funds from it when you need it and leave your everyday money untouched, ready to work for whatever it was meant for originally.
What Is An Emergency?
So, what actually constitutes an emergency when using your emergency fund? You can make everything an emergency just because you want to spend some money. And not every unexpected expense is an emergency either.
In most cases, emergencies will fall under two categories — urgent matters and matters with consequences.
An urgent matter is an emergency or expense that needs your immediate attention. You are driving home from work, and your car breaks down. Later that night, you find out that you need to replace your transmission, but you don’t have enough money in your budget to cover it. That’s an emergency. You need your car for work, running kids around, and general transportation. For many of us, it’s a necessity. Maybe you can get by for a little while, but it needs to be dealt with quickly.
Matters with consequences are expenses that will either snowball into something worse or lead to dire consequences if you don’t take care of them immediately. It could be that you’re in real financial trouble and not tapping into your E-fund could mean losing your house or access to essential utilities, destroying your credit rating, avoiding needed medical treatment, or growing credit card high-interest debt. It could even be that not using it would mean turning to borrowing money at extremely high interest rates.
Here are some of the possible reasons you may need to tap into your emergency fund:
- Job loss
- Medical emergencies
- Pet care
- Car repairs
- Home repairs
- Essential travel
- Other immediate needs
- Urgent financial matters
- Death in the family
Ultimately, it’s on you to determine what constitutes an emergency in your mind (and wallet).
What’s not an emergency?
There are also plenty of other expenses that, while they may not be in your monthly budget, shouldn’t come from your emergency fund. Perhaps you decide to go on a vacation to Universal Studios Orlando, or a new iPhone came out, and you want an upgrade. Maybe you are saving for a down payment for your first home.
These are worthy purchases that we love. However, you’re better off creating sinking funds and setting aside money for expenses like these. Your emergency fund isn’t meant to use if you go over on grocery spending for the month, you want to go shopping, or even to help someone else with their emergencies. It’s meant to protect you and your family, not others. If you like to help others, set aside money each month to use if you encounter others in need.
Related Reading: Values-Based Budgeting: Spending Your Money On What You Love
How Much Should You Save In Your Emergency Fund?
The personal finance experts debate how much you should keep in an emergency fund. Keep too little, and you’re really not prepared for real emergencies. Keep too much, and you could miss out on better returns by keeping your money elsewhere.
Most experts agree that you should save a minimum of three months of expenses, but more often you hear them save keep three to six months of expenses. For us, that’s probably a good estimate, but we hate to put a specific number on something like this.
We’re all different and interact with money differently. For some of us, having a few months of expenses is good enough to cover most unexpected expenses or help us relax. For others, though, there’s real anxiety related to money and the fear of the unknown. You might not be fully comfortable in your financial situation until you have a year or two worth of expenses saved up. And we’re not here to tell you that’s wrong.
The amount you should keep in your emergency fund should be enough to provide relief both financially, emotionally, and mentally and give you peace of mind.
How to build an emergency fund
Follow the steps below to build an emergency fund.
1. Calculate your monthly expenses
Start with your monthly budget. How much do you spend each month? What are your recurring monthly bills and expenses? Typically, these fall into categories like:
- Mortgage (or rent)
Once you’ve created a list of expenses, multiply that by the number of months you want to save for to get the total you need to save. If your monthly expenses add up to $2,000 and you want to keep three months of expenses, you need to save $6,000 total. If you want a year’s worth of expenses, you would need to save $24,000.
2. Set up automatic savings
One of the easiest ways to save towards financial goals is to make it automatic. In the same way that you might get your paycheck by direct deposit automatically instead of cashing a check, you can set up automatic payments from your checking account to your emergency savings. In some cases, your employer might be able to funnel your direct deposit paycheck to multiple accounts. Either way, automating your savings makes it easier to save without spending too much time thinking about it. You can start small and slowly increase how much comes out of each paycheck (or monthly).
3. Set aside unexpected income
If you receive an income tax return or earn a bonus at work, think about adding that to your emergency fund instead of spending it. Using extra money or windfalls will help boost your emergency savings quicker, getting you closer to your goals.
4. Have a plan after you reach your goal
This is unrelated to your emergency fund, but once you hit your mark, you need a plan. You’re already setting aside money for savings automatically. Why not funnel that money towards other financial goals. Maybe it’s to save for travel, a new car, invest more, or pursue financial independence. Whatever it is, have a plan, and use your already-earmarked savings to fund it.
Related Reading: Best Family Budget For Every Personality Type
Where to keep your emergency fund
You have plenty of options for places to keep your emergency fund. Regardless of where you keep it, follow these two rules:
Keep it separate from your other money
Keep your emergency fund somewhere separate from your everyday spending (checking). You don’t want to mix your money. We’re pretty good at keeping tabs on our money, but there’s no way I’d keep track well if our E-fund was in the same checking account that our monthly bills pull from. There’s no way.
Keep it slightly inaccessible
You want your emergency fund accessible, but not too accessible. That’s why you don’t keep it in your primary bank account. It’s too easy to use, whether accidentally or on purpose.
Chances are that if you run into an emergency and need money fast for payment, you may need to use a credit card to cover the cost quickly. Then, you can pull money from your emergency fund to pay off your credit card.
Moving your emergency fund to an online bank might be enough to keep your money untouched for unnecessary expenses, but close enough to use when needed.
Here are some popular options for keeping an emergency fund:
High-Yield Savings Account
A high-yield savings account (HYSA) is a savings account that offers a higher, more competitive interest rate than at your local bank. Instead of earning 0.05% APY, you can find HYSAs that earn 0.50% APY and much higher. Online banks and credit unions are great spots to look for a high-yield savings account to meet your needs.
CIT Bank Savings Builder Account
Features up to 0.45% APY (with Minimum balance of $25,000 or $100 monthly deposit) $100 minimum opening deposit. No monthly maintenance fees.
Money Market Account
You may not know about money market accounts. Basically, they are a hybrid bank account that offers high-yield savings and some checking features like check-writing privileges and a debit card.
Certificate of Deposit
If you wanted to earn a return on your emergency fund, you could put it in a certificate of deposit (CD) account. I’m not a huge fan of this idea, but that’s me. Banks pay customers higher rates to keep money in the back long term.
You can find CDs as short as one month up to five to ten years. That means, your money is tied up for that long, and you could end up paying a penalty (usually a portion of the interest earned) if you pull money from the account before it reaches maturity.
The last thing you want to do is tie your money up long-term if you need it for an emergency.
Another Bank Account
If you already have a bank you like, you could just open another account with them and be done with it. There’s nothing that says you have to earn a ton of interest on your account. It’s a smart idea, but it’s not a necessity. The goal of your emergency fund isn’t to make money necessarily. It’s to protect you.
Something we recently did was move a portion of our emergency fund to an investment account. We kept part of our money liquid in a black-owned bank and then moved part of it to our brokerage account.
Now, we’re not investing our emergency fund in the stock market trying to score huge returns. We’re not out there buying up Apple and Amazon stock or anything like that. We invested the money in low-cost index funds with historically decent returns. There’s still a risk to putting your money in an investment account. You could lose money. Technically, you could lose money keeping your emergency fund in the bank too because of inflation.
Also, we’re not talking about a retirement account. We didn’t put our fund in a 401(k) or IRA. This is a taxable investment account. We can pull this money out at any time if we need it.
What to do if you use your emergency fund
If you have to tap into your emergency fund, it’s ok. That’s what it’s there for. Once, you’ve covered the expense and moved on, it’s time to rebuild it. Use the same process to set aside money each month to get your fund back up to your comfort level. If you have to, pause other financial goals, like saving and investing, until your emergency fund is fully funded again.
Protect yourself and your family
A healthy family money management system all starts with a fully-funded emergency fund. The last thing you want to do is need one after the fact and put yourself in a bad spot financially. We’ve been around long enough to know that it’s not whether or not an emergency will happen. It’s a matter of when it will happen. It’s coming, and you need to be ready.
Do you have an emergency fund? If so, where do you keep yours? Let us know in the comments below.
Kevin Payne is the co-founder and budgeting and family travel enthusiast behind FamilyMoneyAdventure.com.
Kevin is a freelance writer specializing in personal finance and travel. He is a regular contributor to Forbes Advisor, Credit Karma, Fox Business, Credible, CreditCards.com, and Student Loan Planner.