What Is An Emergency Fund And Why You Need One

You may have heard about emergency funds but have no idea about why you need one, how to set one up or how big your emergency fund savings should be. Your emergency fund amount may differ (Is a 6 month emergency fund ideal?), and I explain how to figure it all out. Whether you just need emergency fund ideas or need to learn how to build an emergency fund, this article should answer your questions. Just starting to turn your financial life around?

If so, you may not have heard about an emergency fund or why you need one. I don’t blame you.

You wouldn’t run across emergency funds in everyday conversations, but they are essential to financial success.

What Is An Emergency Fund?

An emergency fund is basically a stash of cash that can bail you out in case of an emergency.

This money should be kept in a liquid (accessible) form should you need it in a hurry.

I personally keep my emergency fund at an online savings account.

My money is still accessible enough that I can get it in a couple days, but I’m not splurging on a non-emergencies because the money takes a couple days to access.

To start your own emergency fund, simply open a new savings account at your bank. Keep the money separate from your other savings and add to it whenever you can until it is fully stocked.

How Much Money Should You Keep In Your Emergency Fund?

There is no set standard amount you should have in your an emergency fund.

Financial guru Dave Ramsey suggests just a $1,000 emergency fund until your debts are paid off while another financial guru, Suze Orman, suggests an 8 month emergency fund.

Trent from The Simple Dollar suggests 2 months of expenses per dependent. As you can see, different people set different requirements for their emergency funds.

You should have an emergency fund that is a comfortable amount for you just in case something horrible happens.

Your emergency fund will need to get you through rough financial times. Luckily, you won’t have to worry about going into debt or incurring a massive credit card bill if your fund is the proper size.

If you have a very specific job that doesn’t have a lot of demand, you might need to have a larger emergency fund, such as 8 months of expenses, because it would be harder to find a new job.

However, if you have a job that is in high demand then you might be able to get away with a smaller emergency fund such as 3 months of expenses.

What Is Considered An Emergency

The only reason to use money out of your emergency fund is a true emergency such as job loss, unexpected medical bills, an emergency breakdown of expensive equipment, such as a car or air conditioner, and other non-expected things.

Unfortunately, many people make up excuses to drain their emergency funds for other non-emergency purposes.

What Isn’t An Emergency

Draining your emergency fund for a non-emergency can be a huge mistake.

For instance, if you decided to splurge with the best intentions of replacing the money and then you lose your job you’re in deep trouble with no financial back up plan.

No, buying a pool for your house is not an emergency. Neither are a bunch of other common excuses people use to take money out of their emergency funds.

Your yearly insurance payments, Christmas gifts, car registrations, property taxes and any other ordinary but non-emergency bill you might think would be a good excuse to drain your emergency fund are not emergencies.

Why Having An Emergency Fund Is Essential

An emergency fund is essential because it can save you from going into debt when something bad happens.

If you’re following the most popular budget in America, living paycheck to paycheck, the smallest little hiccup can be the difference between making it to the next paycheck and going into debt.

When you have your stash of cash, or emergency fund, you can survive the problem without going into debt and incurring interest charges that you can’t afford.

Instead, you can earn interest, even if it is a small amount, and set yourself up to take the next financial steps in your life.

Ideas To Kickstart Your Emergency Fund

If you haven’t yet started an emergency fund, here are a few ways you can get started today.

  • Have a garage sale, sell unwanted items and save the cash.
  • Work one extra shift per month at work and save the extra income.
  • Start a side hustle and save your hard earned earnings.
  • Save the cash and change anytime you break a large bill.
  • Put your tax refund straight in the bank.
  • Get a portion of your direct deposit from work allocated to your emergency fund.

You’ll always be fearing the next unknown emergency or visit from your friend Uncle Murphy unless you have an emergency fund. Don’t tempt fate. Start an emergency fund today and don’t use it for non-emergencies.

Do you have an emergency fund? If so, how did you determine how much to keep in it? Are you comfortable with your current emergency fund or do you wish it was bigger?

Photo by: Images_of_Money Text added by: Lance Cothern

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About Lance Cothern

Lance Cothern, a Certified Public Accountant (CPA) licensed in the Commonwealth of Virginia, is the founder of Money Manifesto. You can read more about him here or connect with him on Facebook, Twitter, Google+ or Pinterest.

Comments

  1. Buying a pool for my house isn’t an emergency? Ha! Good to know!

    But, seriously…my emergency fund is why I’m sane and how I’m able to sleep at night. I don’t know what I would do without that safety net.

  2. We have plenty in savings sort of doing double-duty (saving for long term but currently moonlighting as emergency savings) which is not a great idea I know. Our household needs to set up a savings account with the necessary amount for emergencies that we never touch, except maybe to add $5 monthly (once we’re at the right amount) to keep the account active with the bank.

  3. I never really had a traditional emergency fund because I like to have all m y money working for me. I usually handle emergencies through cash flow or my line of credit. It has worked for me, because I very little debt and plan very well.

    • You probably have enough in the bank/investments that you can take some out. However, if you didn’t have that option relying on a line of credit can be a recipe for disaster. If I were a bank I’d revoke your line as soon as I found out you lost your job!

  4. I think I’m getting stuck in a cycle where NOTHING can be defined as an emergency. I’m trying to anticipate (and by that I mean save for) the unanticipated in every realm – health, car, taxes, job loss – separately, which is sort of silly. Our EF is like $1,200, way too small, but we have all these other bunches of cash in other accounts for other purposes… I think I need a change of mindset on this. We’ve never dipped into our EF as we’ve been able to anticipate stuff that other people might use it for in our other categories.

    • I think if there is a planned event in the future that is health related you should save for that separately, same thing for a planned (or vaguely known) future car replacement or major repair. However, if you’re going to an extreme planning for unlikely events that might need to just be your emergency fund.

  5. Though I am following the established path of building a strong emergency fund, I am starting to lean towards the its-all-savings-you-idiot approach that BudgetsareSexy and Financial Samurai take. In other words $100k in savings is the same as $90k in savings and $10k in emergency funds. I think at this early stage of building that “emergency fund”, we (The Warrior Family) are going to continue calling it that for more of a self-reassuring thing and once it is much larger, then switch to the its-all-savings-anyways approach.

    The Warrior
    NetWorthWarrior.com

  6. Our emergency fund is mostly in a bunch of 5-year CDs. There is a 60-day interest penalty for selling the CDs before they reach their term, but we are still earning around 2% on all of them. The amount is one year of basic expenses. Our fall back, should we run through that is another year of expenses in i-bonds. The main emergency for us would be if the company that both my wife and I work for went out of business or shut our work group down. We plan to retire in 10 years at which point, much of our emergency fund will become retirement assets.

  7. You should put your emergency fund in Roth IRA. You can choose the high interest option at Ally. By putting it in a Roth IRA you don’t lose the annual funding option. A Roth IRA allows you to pull funds out at any time.

  8. I keep a little cash in a savings account. I pay yearly what are normally my monthly bills, like internet, electric, gas, etc. The two together are my emergency fund. Can’t wait till the house is paid and everything gets saved. 21 months to go!

  9. hi thanks for the great ideas.

  10. Great post Lance! Having an emergency fund has kept Murphy at bay plenty of times for us. It always astounds me that so many people live with zero savings set aside for tough times!

    • It amazes me, too. However, I do understand people may not have ever thought of the idea of an emergency fund. That’s why I put this resource together, so people can understand the importance and figure out a way to start saving for one!

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