Emergency Fund Essentials You Need to Know Now

The emergency fund is simply a savings account that you have reserved for unexpected life events. You don’t touch it unless there is an emergency! Having an emergency fund helps you feel secure during trying times which will help you sleep better at night. An emergency fund is critical so that you can have money when an unexpected event happens such as a job layoff, medical expenses, unexpected home expenses, etc.

At the age of 26, I learned—the hard way—why an emergency fund is so important. I was living in Baltimore at the time and had been living there for a little over a year. Financially, I thought I was doing great as I had some savings, investments, and no credit card debt. But then, the housing market slowed down and the company I was working for at the time did a massive layoff. Just like that, I had no job. It was not fun. A few months before, I had bought a brand new car and signed a new lease for my apartment. I only had about $600 in savings. Let me be clear, I never want to be in that situation again!

A major mistake that I made early on was that I started to invest before having a fully-funded emergency fund. I did not know what an emergency fund was at that time. Perhaps you don’t either. So, let me explain what it is, where to keep it, and when to use it. This way you will be conquering that emergency with cash rather than running up credit card debt.

How much money should be in my emergency fund?

An emergency fund has cash that you set aside for emergencies. If you follow Dave Ramsey’s 7 Baby Steps you’ll know that Step 1 in his program is saving a $1,000 emergency fund and in Step 3 you should have 3-6 months of expenses in your fully-funded emergency fund. This aligns with most financial experts from what I’ve read, and some, like Suze Orman, even recommend 8-12 months. You’ll have to decide what your goal is and helps you sleep better at night!

When you look at your budget, you will take the total monthly expenses for a typical month (excluding any monthly savings & investments). Then, multiply your expenses by three. This will give you your minimum emergency fund amount. If you are working your way out of debt, then a one-month fund might be a good goal for your fund.

Many people do not feel comfortable with only three months and prefer at least six. Depending on your circumstances (e.g., job security, family size, number of incomes) and comfort levels, you will need to decide what amount is right for you. I personally like having at least an eight-month emergency fund.

How do I start or build an emergency fund?

Starting an emergency fund can seem overwhelming if you don’t have one currently. So, I’m going to give you a few tips and ways to at least start a small fund.

1. Pay yourself first. Your monthly budget should include money that you are saving. You will always have expenses that you do not expect. This is a part of life so you should plan and budget for it. If you don’t have a budget yet, take control of your cash and create one.
2. Sell some of your stuff. I am sure you have plenty of things in your home that you do not use and are worth some amount of money. Consider selling some items on places like Facebook Marketplace and Craigslist so that you can quickly get some extra cash. One thing that I think many of us have a surplus of is clothes. If you have extra clothes that you’re not using then consider taking them to a consignment store or listing them yourself. If you have kids you probably have a lot of extra toys laying around that the kids don’t actually play with anymore, these are really easy to sell through Facebook Marketplace or again through a consignment store. Selling extras is something that can help you really quickly save up anywhere from $500-$1000.
3. Reduce your spending. There are probably a few items in your budget that you can cut out or cut back on. Two big ones are typically food and shopping. Check out my quick hitters for reducing your spending.
4. Get another job. While having another job for the long term may not sound appealing, it may be necessary depending on your current cash flow and expenses. Getting a side hustle can really help eliminate debt and build wealth, depending on where you are in your journey.

What kind of account should my emergency fund be in?

The whole point of an emergency fund is to have the money when you need it. So your money should be placed in a location that is easily available and in a cash account. I recommend finding a high-yield savings account. Money markets used to be a good place to put your money to get slightly higher returns but these days a high-yield savings account will most likely yield the same results. A good place to look at rates is on Bankrate. In general, I like to keep mine in a separate bank than my checking so that in order to use it I would have to transfer money and wait a few days.

Should I invest my emergency fund?

No! You should not invest your emergency fund. Let me say that again. You should not invest your emergency fund! As tempting as it may be, you should keep your emergency fund money in a savings account so that it is readily available to you when you need it. Currently, the rates for savings accounts are not great but remember the whole point of the emergency fund is to have money when you need it; it is not an investment, so don’t treat it like one.

Invested money can go up and down and it isn’t always liquid. For example, if you invest your emergency fund in the stock market you would be withdrawing it when you need it rather than at the best time to sell it, which may result in selling your stocks when they are undervalued or at a loss. For example, if a recession hits and you lose your job, it is a lot more likely that your emergency fund is not going to be at the value that you need to be. Don’t risk it!

If you are really adamant about putting your money in some type of “investment”, then you might consider a bond fund in a Roth IRA since it would be low risk and contributions can be withdrawn without penalty. However, at least three months of your emergency fund should still be in a low-risk account such as a high-yield savings account. That’s my opinion at least!

When should I use my emergency fund?

It is very important that you only use this account for emergencies. What might qualify as an emergency can be pretty subjective, especially depending on one’s financial situation. 

Yesterday my 2007 CRV was inspected and I was told that my car needs new tires. Is this an emergency, should I use my emergency fund? The answer is no because this is an expected expense; I own a car and they require maintenance. I will instead use my sinking funds. Sinking funds are a different type of account that would be used for planned or expected expenses like car repairs, a vacation, a new laundry machine, a new car, etc.

However, if you are not out of debt yet or don’t have a sinking fund yet, you may end up using your emergency fund as you might not be able to cash flow it, so it actually is an emergency. As you save more money and are better off financially, you’ll be able to either cash flow these types of purchases or use your sinking funds (kept in another account), and keep the emergency fund for unplanned major expenses. 

When you use your emergency fund, it should be reserved for major, unplanned life events such as losing your job, medical, unforeseen home repairs (e.g., refrigerator breaks, flooding), etc. It should not be for a new car or a vacation. It can be tempting because that money is just sitting there. But remember, the point is to have security! The moment you spend that money you don’t have your safety net.

If you do have to use some of it, then you should rebuild it as soon as possible.

I hope this helps you get started!

~Rebecca

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