The emergency fund. It’s one of the first lessons in personal finance 101.
A stack of cash that you have saved for a “rainy day.”
Yes, you should have one. But there are a lot of complexities and variables in the why, how, and what of building an emergency fund.
Reasons To Have An Emergency Fund
Let’s start with the why. Your emergency fund is the financial buffer between you and life happening.
You’ll most commonly hear that the reason to have an emergency fund is to protect you against financial instability. And there WILL be plenty of times in your life that you have an unexpected increase in expenses or a loss of an income.
- Job Loss
- Car Problems
- Home Repairs
- Medical Emergencies
- Income Instability
But there are also “positive” reasons to have an emergency fund as well. Your emergency fund can provide you benefits beyond protection against expenses.
The peace of mind that comes along with having an emergency fund is irreplaceable. Knowing that you have a buffer in case something happens can greatly reduce financial anxiety, which is a huge issue for many people.
Then there is also the “FU Money” aspect of having an emergency fund. Having a pile of cash laying around enables you to make more bold choices in life. You’d be surprised how your mindset and actions change when you don’t need to do something for money.
And finally, the emergency fund is a great way to avoid debt. If you are not relying on credit cards or other loans to “protect” yourself, you are far less likely to go into debt. And I hate debt.
How big should your emergency fund be?
There is certainly no right answer on how large your emergency fund should be. There are MANY variables, some objective, and some subjective, that go into how big of a cushion you might need.
Generally speaking, the most common financial advice is 3-6 months of expenses. But where you fall in that range is dependent on other factors.
|Smaller Emergency Fund
|Larger Emergency Fund
|Low Essential Expenses
|High Essential Expenses
|High Risk Tolerance
|Low Risk Tolerance
For somebody like myself, where my wife and I both have variable incomes, and we have two kids in daycare (high essential expenses), we keep our emergency fund on the larger end.
However, if you are a person with a very stable job, and/or low fixed costs, you can get away being on the lower end.
How much money you want in your emergency fund is a decision that is up to you. It is just important that you are intentional about it, and pick a number that is right for your financial situation.
Where should you keep your emergency fund?
The whole point of an emergency fund is stability and access to cash quickly. So most or all of your cash should be stored in a savings account.
I personally keep a majority of our emergency fund cash in an online high yield savings account (through Ally Bank). These online savings accounts are not going to make you wealthy, but they at least pay an interest rate that keeps pace with inflation.
Yes, there is a “cost” associated with having an emergency fund. The money sitting in your savings account is not invested in higher returning assets. But I see that cost as the price to pay for financial safety… and it’s well worth it.