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Emergency Funds: Everything You’ve Ever Wanted To Know

An emergency fund is the backbone of financial security.Note from David: Wherever you are on the journey to “getting better with money”, the concept of an emergency fund—rainy day savings that will be there for you in case the unthinkable happens—is critical.

I know, I know, it’s personal finance 101. Everybody preaches: “You MUST have an emergency fund! In case you get sick. In case your car breaks down. In case you lose your job.”

So if you’ve been reading personal finance blogs for a while, you’re probably thinking “yawn, more of the same.”

I’ll be the first to admit, there’s not much NEW we can say about emergency funds.

But because having some money put aside is simply so vital to getting on your feet financially—which is what this site is here to help you do—I asked Amber to put together this comprehensive article on them. You can also check out our emergency fund calculator to help you figure out just how much should be in your emergency fund.

Got a burning question about emergency funds? Please ask it in a comment—we’ll do our best to get you an answer, or at least throw it to other readers to get a conversation going.

Here’s Amber:

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If you lost your job tomorrow, do you know how you’ll pay the rent next month?

If your car’s transmission broke and required a $2,000 repair to be back on the road, could you pay the bill without going into debt?

For more than half of Americans, the answer is no. And chances are, among us younger (and poorer) Americans, the percentage is higher.

The answer to both of these potential problems is to have a good chunk of money set aside in savings…a rainy day fund if you will, or as we financial nerds call it: an emergency fund.

Emergency funds are like insurance: confusing and boring, but downright necessary. You shouldn’t drive without car insurance and, quite frankly, you shouldn’t try to live life without emergency savings.

If you, like many Americans, haven’t been able to save an emergency fund or have put it off because you don’t think you’ll need one, consider what you would do if suddenly you found yourself with a $1,500 repair bill or, worse, without an income.

Emergency funds could be the most vital part of your financial plan, so you really owe it to yourself to make a plan to build yours today. We’ve put together a step-by-step guide to creating your very own emergency savings—from the initial buffer to the fully-funded emergency fund.

WHAT IS AN EMERGENCY FUND?

Before we break down exactly what an emergency fund is, let’s define what it is not:

  • It is not used for planned purchases like a house, a new car, a college education, and so on.
  • It does not have to a large, unattainable amount; it can start small.
  • It is not a set amount for everyone—it varies based on your lifestyle.

Now that you know what it’s not, let’s talk about what it is.

WHY YOU NEED ONE

An emergency fund serves two major purposes:

  1. It creates a financial safety net during emergencies like a job loss, illness, or major unexpected expense.
  2. It allows you to avoid the use of credit cards or loans during said emergency.

Unfortunately, there are plenty of times you may need an emergency fund. Some may be scary and severe—like a job loss or chronic medical condition—but others are simple expenses that you just weren’t expecting—like a car or home repair.

Now that you know exactly what an emergency fund is and why you need one, it’s time to look at building it!. Here at Money Under 30, we think that savings “buffer” of $500 to $800 is the best way to start.

Step 1: Build a Buffer

Last year, we wrote about 6.5 half steps to financial stability. The first and arguably most important step is to build a savings buffer of $500 to $800.

If you’re in debt, it’s tempting to throw every extra penny towards your debt. However, it’s better the build at least a small buffer of $500 to $800 dollars in savings before attacking your debt.

Those amounts may seem small, but when you’re in debt, they’re really not. When I was in debt and living paycheck to paycheck, I couldn’t seem to save even $100. Whenever you feel like you’re making progress, something comes up and you fall behind again.

So if you can’t even get ahead in your debt payments, how will you ever save extra money on top of that?

There are three primary ways to scrape together extra funds to build your primary buffer before you start tackling your debt payoff and, later, building a stronger emergency fund.

  1. Reduce discretionary spending
  2. Cut recurring expenses
  3. Earn more

You can choose to focus on one of these items or all three to scrape together any extra cash you can.

Cutting back is easy for some people, but it just doesn’t work for everyone; that’s why building an extra income stream is vital if you can’t seem to find any extra dollars to build your buffer. Whether it’s picking up a couple extra hours at work, creating a freelance business, applying for a part-time job or creating an online store, figure out what fits best with your available time and skills.

Here are some great articles that break down tips on how to earn more money:

And by the way, in case it’s not obvious, you don’t need to get a second job or start freelancing to earn enough cash to start that emergency fund…it could be simple as finding a few things you don’t use anymore and selling them on Craigslist or eBay.

WHERE TO PUT THAT MONEY

If you ever do have the need to use your emergency fund, you’ll need access to the fund quickly if not immediately.

This is why you shouldn’t maintain your mutual fund in stocks, CDs or bonds—you’ll need to keep your emergency fund liquid. The best and easiest way to do this is by using a basic savings account, either online or at your local bank. We recommend keeping the account at a different bank than your primary checking account to reduce the temptation to tap it for non-emergencies.

Remember, an emergency fund is for security, not earning a return. While you should absolutely get the best interest rate you can find while keeping your money accessible, don’t be tempted to chase yields and lock up money you might need tomorrow in an investment that may be more difficult to liquidate.

HOW MUCH DO YOU NEED?

Everybody—financial experts and amateur advisors alike—has a different opinion on how much money you should keep in your emergency fund.

In general, however, your ultimate goal should be to have enough money in an emergency fund to pay your essential expenses for several months. Some experts say six months, others nine, or twelve.

We recommend figuring out what makes you comfortable.

At the very least, you should have enough money set aside to cover a big unexpected expense without turning to credit cards. Then, ideally, you would have enough money to get you by in case you lost your job and had to find a new one.

(Hint: The more difficult you think it will be to find a new job in your field, the more you may want to save!)

Step 2: Build Your Emergency Fund

Once you’ve created your buffer—and completed steps two and three in the 6.5 Steps to Financial Stability list—it’s time to start building a sustainable emergency fund.

Building the emergency fund will be very similar to creating your initial buffer.  If you’ve already reduced spending and/or created extra income, a percentage of that cash should go to your emergency fund.

Here are some helpful tips (in addition to reducing spending and/or earning more) for building that emergency fund:

  • Direct Deposit. If you’re tempted to spend extra cash, set up a direct deposit into your separate emergency fund account. (Pay yourself first.)
  • Bill Yourself. If you don’t have access to direct deposit, treat your monthly emergency fund allotment as a bill—like rent or your electricity payment. Remember to deposit that amount into your savings on whatever day of the month works for your situation. (Same idea as above—pay yourself like any other bill).
  • Add Bonus Money. Use things like tax refunds, mail-in rebate checks, or unexpected windfalls to add a boost to your e-fund.

Here are some more ideas:

Establishing an emergency fund may not be the most fun or exciting part of creating financial stability, but the safety net it creates is worth more than the actual dollar amount it contains. It’s the first step towards financial freedom that can keep you on the right financial path even if life’s events try to knock you off.

Ask Your Question About Emergency Funds

What do you want to know about emergency funds? I’m sure there are plenty of questions we haven’t covered, so ask yours in a comment and we’ll select the best ones to answer. Other readers may have some good ideas to share in response, too. Leave your question in a comment now.

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About Amber Gilstrap

Amber is a twenty-something CPA from Kansas City, Missouri who loves writing, working out, and---of course---finding fresh ideas for saving money. Follow her on twitter @ambergilstrap.

Comments

  1. This is so much easier said than done! I always feel like I can “outsmart” an emergency fund, which is, of course, ridiculous. I’m having a few slow months though, and it would feel really nice to have savings that are JUST for emergencies, not that I feel like I could use for other stuff.

  2. I have almost reached my goal of $10,000 in an emergency fund.

    However, up until recently, I’ve just kind of seen my regular savings account (money marking checking account) as my emergency fund. Once I reach $10,000, should I stop there, leave that account at exactly $10,000, and open up a new (separate) savings account that is not specifically for my emergency fund? Or should I just keep dishing all my extra money into that account? Is there a point to having the emergency fund be separate when I have no intention of dipping into ANY of my savings?

    When I start saving for a wedding, I can see the purpose to opening a separate account for that. But what about now, when my only goal is to save every penny possible?

    I’m working at my first post-college job and am saving just under half my income monthly. I have no debt and a tiny (brand new!) retirement account.

    • David Weliver says:

      Good question, Hannah. Personally, I just have one savings account that holds our emergency fund and additional savings. My wife and I have agreed on $30k as an ample emergency fund but we continue to autosave amounts above that balance each week in the same account. Like you, we don’t plan on touching that.

      What we do that may be fairly unconventional is keep a larger-than-normal checking balance and pay for things like vacations or big purchases directly form that. If we know we have an expense coming up, we’ll keep more in checking rather than transfer it to savings or an investment account. (Mostly this is because interest rates are so low right now; if they were higher, I would likely open a second savings account for short term savings goals).

      I would think that’s a good way to go for your wedding but think you’re fine with one account for now.

      I do know people that have a half dozen savings accounts for different things, too, but I personally think that’s overkill.

  3. I want to add something that I haven’t seen anyone mention in emergency fund articles. Most banks waive monthly account fees for maintaining a minimum balance in your chequing account.

    I keep my $5000 emergency fund and a $2500 buffer for expenses in my chequing account in a premium service account at TD Canada Trust ($25/month fee if the balance drops below $5000 at any point during the month). I use included services that would cost more than the $300/year fee if purchased individually (Unlimited Chequing, Drafts, debit card fees at other banks locally and internationally, safety deposit box, US$ account, Visa Infinite rewards card(similar to Visa Signature in the US).

    I believe I would end up paying the $25/month anyway, so I’m earning 6% on that $5000 by avoiding the fee. That’s far better than I could do investing it in any guaranteed investment.

    And the $25/month fee is enough of a stick to keep me from spending into it, but I can change my account type to something cheaper if I have an emergency that I really need to get at that money on very little notice.

  4. I find the happiest place for my e-fund is in CDs. They are safe, they grow slowly but they do grow, and there is a big fat penalty if you try to touch it ahead of time. Because think about what the purpose of this money really is – Emergencies. Some people may need to think on that word a while. Yes, emergencies are unplanned, and yes, CDs have fixed penalties for using your money at an unplanned time. Look for CDs with a reasonable penalty for early withdrawal – about 2 months worth of interest. Then don’t dump all of the money in 1 CD – do a ladder so you will have money coming due to you every few months to roll over into the next.
    For example 6 month, 9 month, 12 month, 18 month, 5 year.

    • I’m actually doing something similar. Our target is $12k, so I’ve got $6k in a money market account. Each month for the next 12 months, I’m going to open a new 12-month CD with $500 (12 x $500 = $6000). That way, I’m never more than a month away from the next $500 and I’ve still got the $6k in the money market that I can use immediately if I have to. The penalty on pulling out of the CD is pennies (literally), but the interest rate is slightly higher than what my savings gets.

      I’m not trying to “invest” with that money so I don’t want anything long-term…just secure and earning something slightly better than nothing. If you get something with a longer term than about 12 or 24 months, then you’d probably be better off in a riskier “investment” like a mutual fund.

      • I can see in theory where this would work, but keeping track of all those CDs for a dollar or two in interest doesn’t seem worth it. Just the process of opening them probably takes enough time that you are actually losing money if you look at how much money you make per hour. On the other hand, if this system gives you peace of mind it would definitely be worth it.

        • Mom Equity
          I can see how it *sounds* complicated to set up, once running it runs itself and it really earns you way more than you might think for money that is otherwise going to earn nothing at all. All it takes is filling out a form and sending in a check. When the first one expires, you just roll it over into a new CD or cash it out. Your bank will mail you a form to do this hassle free. My regular savings account paid me .01 cent last month. 1 cent. And they mailed me a statement to prove it! While during that same time my CDs brought in $45. Use an online calculator to figure out what your total profit will be.

          Chase – I don’t invest emergency money so I’m pretty happy with the 5 year CD. If there is ever a true emergency in my life, I do not want to also be worrying about what the market is up to with my cash!

          • Haha! Hilarious about the statement printed and mailed to tell you about your $.01!!! Thanks for the advice!

          • It sounds like you might be better off finding a higher interest rate on a savings account. $6,000 in a savings account could be earning $5 a month.

            Also I am wondering how you are earning $45 a month on $6,000 of CD’s. That is about a 9% return which seems unrealistic. Maybe I am misunderstanding this somehow?

        • I use Ally and it took me about 5 minutes to set it up and fund it online. I can track all of them in one place and see how much money I’m earning each day.

  5. I’m 22 years old and currently have about $2,000 in an emergency fund. I’d like to get it up near $5,000.
    I’m working full-time and living in a very expensive area (admittedly by choice). I have no debt but fter bills and other expenses I’m only able to save about $100 a month into an emergency fund.

    I am concerned that at this rate I won’t get anywhere. Any tips on balancing emergency fund savings with funding an IRA as well as saving for life? I could easily jack it up a few hundred bucks, but it would be at the expense of other worthy costs. I’m a disciplined saver but want to be sure not to miss out on other things in life. Any advice appreciated!

    • Travis,

      You have to look at the math. If you are only able to put away $100 per month, then you have to evaluate which is more prudent: invest in an IRA or build an emergency fund. You have to go with the emergency fund. In an IRA, the money is not liquid, you cannot touch it with out heavy penalties. You are bot missing out on much growth with only $100 a month in an IRA. Given that you have no leeway in your monthly income, wouldn’t it make more sense to have cash stashed away that you can get to in an emergency (in your case, anything over a couple hundred bucks)?

      Build your emergency fund first, then build the IRA.

      • This is one why I like the Roth IRAs: because you can take the principle out without penalty after 5 years AND you can get an exemption for college expenses.

    • David Weliver says:

      Travis, I agree with Drew…focus on one thing at a time. Although it’s important to start saving for retirement early, a safety net of cash is the more immediate priority. The psychology of having the single goal is helpful, too. Zone in on reaching that $5,000k mark and you’ll get there faster than you think.

      • Thanks for the advice.

        I agree that having one single financial goal would be helpful in managing my budget. I don’t have an employer match, so I’m not losing that. Sounds like the best idea is to aggressively build my emergency fund until I reach my goal. Even if I wait another 1-2 years before I start saving into my IRA, it seems like I’ll still be on track to build a good retirement account. Does this sound right?

        • Travis,
          You are only 22 years old and already have $2000 in an ER fund????? Way to go!!!! Congrats. I agree with the others – keep your eye on the ball and get that baby up to $5000. It really will happen faster than you think. Once that is in place, get yourself a 401(k) and then automatically have15% of your GROSS put into a 401(k) or a Roth IRA – maybe split that 1/2 and 1/2. It’s not as hard as you think it will be. It hurts at first, but sooner than you know, it doesn’t even register on your radar screen. And you will be SOOOOOOOOOOOOOOOOO happy that you did that when you’re 55 years old and getting a little tired of your job. I know, at 22, that doesn’t generally seem possible – but it happens ALL the time. Just get that ER fund up to $5K and then save 15% of your gross income. You’ll have the world by the tail.

    • First, pat yourself on your back for having $2000 socked away at age 22. But I think you need to revisit your expenses. It’s hard to say because I don’t know your salary, but you say you live in a very expensive area by choice, so I’m assuming you make a decent salary. Don’t fall into the trap of living at 100% of your income. That’s basically paycheck to paycheck. Take advantage of time and your youth to sock away as much as you can into a 401k or IRA. I wasted a good 10 years piddling around before I got serious about that.

  6. diane williamson says:

    I am close to 71 yrs. old; retired, earn extra money, but I am taxed to death. I end up buying for and financially helping my five children and granddaughter. They are all adults, and not dependents. A 2006 equity loan just before the crash wiped out any house value. Since it was not my primary mortgage lender, I can pay my house payment, but it’s basically rent. I am nickled and pennied to death with appliance, house, and car maintenance. my basic house, utilities, med and life ins., auto expenses take up to 80% of my retirement of $3500.gross a month. I owe 100,000 on my equity, and a bankruptcy in 2007 wiped out credit card debt. That $3500. is before taxes. I spend $1000. a yr on trips to visit children and relatives. I’d surely get rid of the car, but living in CA sprawl with a poor city transportation system, is not feasible. I realize that I’m better off than many, but can’t maintain a savings account.

    • Dianne,
      5 kids and a granddaughter that are leaching off of you when your 70 years old? Grow a spine and tell them to grow up. NO MORE $ FOR THEM – not from you anyway. How are set up for retirement? I’m guessing not very well. You need to save for YOURSELF. Those kids of yours sound like they’re healthy and able to fend for themselves. Make them do it. You are not to be their cash cow – not at your age.

  7. I like calling is a cash reserve, part of which can be your energency fund. With the stock market swinging like it is a person with cash can really capitalize on the downswings, while keeping the emergency fund intact. FOllow the same principles described here. just don’t stop when you have six months expenses. Keep going until you feel you have enough to retire!

    • Agreed! I don’t believe you can ever have enough in emergency savings. It is something that will always have to be probably be replenished. It’s nice to have six months worth of emergency savings but wouldn’t it be nicer to have six years worth?

  8. I have built my emergency fund past several years. I also have a home equity line of credit that I can always lean on if I need money on emergency situations. Currently, I have outstanding balance on my HELOC. I’m wondering if it is a wise decision to pay off my HELOC balance with my emergency fund right now. By paying off now, I end up not paying the interest. Would you recommend this option? Thanks.

    • I’m in a somewhat similar position. I still owe on one of my cars. I want to pay it down as soon as possible to avoid the interest. I feel it is a better idea to have a 6 month emergency fund at all times. Anything I save beyond that then goes towards my car payment. Currently I am making triple car payments while conserving my emergency fund. I like having that safety net. In your case, you might be able to get away with using some of your emergency fund since you can always dip back into your HELOC. It really depends on 2 things: how much you have in the emergency fund and the interest rate on your HELOC. If you have a fat emergency fund, a high interest rate, and a stable career, then you might consider using it. However, if the interest rate is low or you have a small emergency fund, then you must look at the numbers and see how much in interest you are actually saving and is it worth it to take on the additional risk of a smaller emergency fund. A side note, I am not a big fan of HELOCs as you are basically taking a second loan on your house….so If I were you, I would avoid using it if you can.

    • This is a tough question that so many people have: “With extra money, should I pay down low-interest debt or stockpile savings?”

      First, you need to figure out where you stand philosophically on debt. For example, Dave Ramsey hates all debt In his eyes, the answer is simple, pay off the HELOC and never look back.

      Other people are fine with using debt as leverage so they can invest money and get a better return. If this is you, are you investing money in a way that will hopefully outpace the APR (interest and fees) you pay on the HELOC? If so, then OK. If not, then I would pay the HELOC off (as long as after paying it off you still have a 6-month emergency fund.)

      My personal view on debt is that I want to minimize it but will consider borrowing at low rates over short terms for clearly defined goals (examples: your home, a college degree, or to start a business). Therefore using a HELOC or other loan as an emergency fund probably wouldn’t fit in, so I’d pay off the balance.

  9. Thanks for breaking this down for me.

  10. Hello,

    This is a great article.

    I am working on establishing an emergency fund and also trying to put money away into my Roth IRA for retirement. I also want to try to set up a savings for home projects/vacations/etc. Is it recommended to keep one savings account and just keep building it up for all of these things or to keep seperate accounts? Also, what amount or percentage is a reasonable amount to put into each account – meaning should I only put a little away for retirement and put more in the emergency fund now?

    Thank you for your help.

  11. I too saw that story about how 1/2 of those here in the US couldn’t cover an unexpected expense of $2,000 within a month I believe. Staggering, but probably shouldn’t be surprising the more I think about it.

    Personally, I think that the old formulas of keeping 3 months expenses in an emergency fund are too low. More like 6 to 9 months easily, these days and in this economy. Best to be safe, because things can and do happen.

    • I too was suprised considering that I usually have a few thousand available in my checking account available at any moment in time and sometimes keep a few hundred bucks in cash hidden away in my place.

      I guess I should feel very fortunate considering then…

  12. I don’t understand the “you shouldn’t maintain your mutual fund in stocks, CDs or bonds” arguement. I mean most brokerages you can link your checking or savings account right to your brokerage account so if you need the money, you sell the investment and it’s either in your account that same day (if made a few hours before market close) or the next day…or maybe my brokerage is just really speedy.

    Yes, I can understand keeping some cash for IMMEDIATE immediate needs, but it’s not like there are many scenarios where you absolutely need to make the payment that exact date. With checks it may be days before the check is cashed (depends on how quickly it gets cashed) and if you really need to delay paying something, charge it to your credit card so you have an interest free loan for a few days to a month (depending on the billing cycle)…though it’s only interest free if you pay off the credit card charge at the next statement date if you’ve made money available.

    But again, I still stress that there aren’t many things out there that require payment the day of that emergency. Things like car repairs, rent, etc can be charged to a credit card and paid off at the next statement.

  13. With the worldwide economic crisis, people lose job everyday and even if we are confident about our income today, but never sure what tomorrow could bring. Saving money entail great advantages for our personal finance in the long run.

  14. Im 27 and Started a new job last summer. It was fine at first, but after a few months I started to question the stability of the company. I figured it was in my best interest to start an emergency fund–just something to pad my income if I had to go on unemployment. Boy am I glad I did…I was recently given a 60 day layoff notice since my company is going out of business. I have close to $3,000 saved so far, and will hopefully have around $5,000 by the time I am laid off. I can sleep at night knowing that I have that money in the bank…

  15. I have 30K in my savings and spend from my checking where I only keep 2000 for living expenses the rest of my paycheck I move to the savings account. My employer matches contributions up to 3% on my 401k where I set 5% of income I just started this a year ago and have 10k here.
    My question is how can I make my savings grow faster, but still have access to some of it without huge penalties instead of keeping all my money in savings where I only earn a lil bit more than nothing!

    • Leah,
      Roth IRA – in mutual funds. You can take out whatever you contribute anytime without penalties (you just can’t withdraw what you make on the account).

  16. Typically how fast should you build up your emergency fund? What % of your excess income should go towards it?