Emergency Fund 101: Everything You Need to Know
Saving for an emergency fund is, in my opinion, one of the least fun financial goals you can possibly have. But it’s also arguably the most important. Having an emergency fund is the first place you should start when getting your financial life in order. Today I’m answering all your questions about emergency funds.
What is an emergency fund?
It’s a savings account with a minimum goal of $1000 to be used for emergencies only. If you foresee car repairs in your near future, that does not count as an emergency. This money is set aside for things that are unforeseen and outside your power. Think car accident, house fire, or getting laid off from your job.
Do I really need an emergency fund?
Yes.
But here’s why. The fact is, emergencies do happen sometime or later. It’s better to be prepared for when it will inevitably happen rather than hope that it won’t. Imagine that you just got a new job with an awesome new salary. You’ve been keeping a tight budget for months. But now you have a little extra spending money and you want to treat yourself. Besides, you just got a new job, so you can make up for the money next month.
But then imagine that someone without insurance rear-ends you on your way to work one morning. It’ll take a while for your insurance company to work things out, and then even longer to get your car fixed. Since you just started your job, you don’t have any leave built up. Imagine how much less stressed you’ll feel knowing that you have an emergency fund to get yourself to work until your car problem is resolved.
Even if you have insurance for all your valuables, it’s still important to have an emergency fund. Sometimes it can take quite a while for insurance money to come through. If your house burns down (though I sincerely hope it doesn’t!) you’ll need a place to stay, new clothes and toiletries, and food to eat that very night. There’s no waiting for insurance money to buy all that.
Can’t I just use my credit card for emergencies?
You might be thinking that you can just put a rental car or any repairs necessary on a credit card, but this is dangerous for several reasons.
- You’ll most likely end up paying a lot extra in interest. Many credit cards are upwards of 20% APR in interest. That adds up really fast.
- Instead of building your emergency fund back up, you are now just paying off your credit card + interest.
- There are some things that you can’t actually pay with a credit card. A contractor might not accept credit cards for repairs on your home. While plastic works most of the time, it’s no guarantee.
- Your issuer can actually cancel or reduce your credit line. While this doesn’t happen often, it’s certainly within the realm of possibilities. Especially if you get laid off.
You should never use your credit card as your emergency plan.
How much should I keep in an emergency fund?
While you’re paying down debt:
Many experts recommend having at least $1,000 in your emergency fund until you get out of debt. For example, if you have $2,000 in credit card debt and $15,000 in student loans, you might consider having an emergency fund of only $1,000 while you aggressively pay off your debt. This means that all your extra moneyis going to go toward your debt, including things like your tax returnand birthday money. The $1,000 cushion will help you with most emergencies, such as a last minute car repair, a vet bill, etc, while you aggressively pay down debt and avoid paying more in interest.
When you don’t have debt:
After you’ve paid off all your debt (except for a mortgage), then you should start saving for 3 to 6 months of living expenses in your emergency fund. This will protect you if you lose your job for some reason. Losing your job is stressful enough. It could be much less stressful if you know that you have 3 to 6 months to find a new one before you start going into debt.
Calculate how much money you need to spend to keep your household running. You’ll want to include things like rent, insurance, food, gas, etc. That’s your monthly living expense. Then multiply that by at least three.
You only need to have three months’ worth in your emergency fund in situations where you have a secure job, have little monthly expenses, or your spouse brings in enough to cover your monthly expenses. Circumstances in which you definitely want to have 6 months’ living expenses in your emergency fund are if your job isn’t as secure (perhaps a seasonal job), you’re self-employed, your the primary breadwinner, or your income fluctuates significantly month to month.
Where should I keep my emergency fund?
Three to six months of living expenses is no small chunk of change. While it might be tempting to invest it somewhere and watch it grow, it’s a much better idea to keep your emergency fund liquid. Your best bet is to keep it in a designated savings account or Money Market account. You want to be able to get to your money quickly. It’s not really an emergency if it’s planned out, so you’re only going to need to access it at the last minute.
We have our emergency fund in a Capital One 360 account. This is a good option because we can get to it quickly if we need to, but it also accrues more interest than a normal brick and mortar bank savings account will. As of the time I’m writing this, our money earns about 1% APY just sitting there. That’s not a huge amount, but it’s pretty good considering how accessible it is. Our other bank only offers .05% APY.
One thing I love about the Capital One 360 account is that it’s easy to open more than one savings account. I find it really helpful to have different savings goals in different accounts. It makes me much less tempted to use my emergency fund for other savings goals, like our travel fund or our car fund. If you’re interested in opening an account, you can use my referral link to get a $25 bonus.
How do I keep myself motivated to keep contributing to my emergency fund?
Saving that much money is no easy feat. And as I said earlier, I don’t think that it’s a very fun financial goal either. What’s kept us motivated in saving is the idea of how much more financially stable we’ll be once we reach our goal. It’s important to keep the WHY in mind.
But sometimes even that doesn’t seem like a good enough reason. Since saving an emergency fund is an important commitment to me, I know that I’m going to keep working at it even if I have some hard months. Some months the only way I can convince myself not to reallocate the money is by reminding myself that I can start working on other, more exciting financial goals after our emergency fund is all topped off. Until we’ve built up our emergency fund, it would be risky to save up for a down payment on a house, go on a super fancy vacation, etc.
Other strategies for saving an emergency fund?
I have two words for you. Automatic drafts. I think that setting up automatic drafts are crucial for any type of savings goal. It’s great accountability and you don’t have to think about it. Set up the drafts to occur right after you get your paycheck. You’ll be surprised how quickly you adjust to having that money automatically taken away. It’s almost as if it was never in your account.
It’s also important to check your accounts often. If there’s anything less fun than putting your money in an emergency fund, it’s paying overdraft fees. That’s why you want to make sure that you’ve kept enough in your checking account to pay your bills after your savings has been taken out. Eventually, this will become a habit. Besides, it feels really good knowing where your money is instead of wondering if you’ll have enough.
How do you track your progress on your emergency fund?
I love to use Mint to keep track of our finances. On the desktop version of the website, they have a goals page that is fun to use. There are several different ways you can set your goals up. Seeing myself get closer to the goal each month is incredibly exciting and motivating. Getting ahead is even more exciting.
There are a lot of other ways to keep track of your progress too. Lots of people use bullet journals. Just google “bullet journal emergency fund” and you’ll find lots of ideas. If you have kids and want to get them involved, you can print out a chart and have them help you fill it in each time you save a certain amount. Capital One 360 also has a way for you to track your savings goal.
The important thing is that you learn what works for you and keep at it. Don’t be afraid to track your savings goal in more than one way.
A Final Note
While saving for an emergency fund may not seem like fun, it’ll get you one step closer to living the better life. Once you’re prepared for an emergency, you can focus on other things like
- buying a house
- getting your dream job
- going on the trip of your dreams.
- save to upgrade your car
- quit your job and start your own company
- support the causes you love
Saving up an emergency fund is a lot of work but it’s more than worth it. My husband and I are currently at 54% of our savings goal. Know that we’re in the race with you and cheering you on! We can do this!
