What is an Emergency Fund?

You’ve probably heard it from a dozen different personal finance gurus, including Dave Ramsay and Suze Orman: You need an emergency fund! But what exactly is an emergency fund?

An emergency fund is nothing more than a simple savings account that you put money into in the event you face sudden, unexpected expenses that you cannot pay with the cash you have on hand in your checking account. These emergencies might include your car breaking down, a trip to the Emergency Room, or a major appliance breaking in your home. The financially smart way to handle these “emergencies” is to have cash already saved up—in an emergency fund—to pay the bill and not use a credit card!

But emergency funds also provide one other major benefit: Security if you lose your source of income. Not only should an emergency fund be available for unexpected expenses, it should be there for you if you lose your job to help you pay the bills while you find new work. That is why, while any emergency fund is better than none, you will ideally want to try to save between three and six months worth of living expenses in your emergency fund. The more you earn and the more specialized your job, the bigger your emergency fund needs to be to protect your finances should you become unemployed.

Finally, your emergency fund needs to be liquid. That means you can easily access the account to transfer money in and out of within few days. This means that investments—especially retirement accounts—do not count as emergency funds. Although many people take money out of retirement accounts like 401(k)s and IRAs when they lose their job, this is a terrible financial mistake, as you will pay taxes and a 10% penalty on any retirement funds you withdraw early.

For more on emergency funds, read: How much should be in your emergency fund?