Everything You Need to Know About Emergency Funds

One of the smartest moves you can make with your finances is to build an emergency fund.

An emergency fund is money you set aside for the unexpected expenses or unforeseen events that pop up in life.

Your emergency fund would cover things like a job loss, unexpected emergency room visit, major unexpected home repairs, etc. It acts as a buffer so that these events don’t throw you into (or deeper into) debt.

Your grandma might have told you to always put some money away for a rainy day. Grandma was talking about your emergency fund.

We know that “rainy days” inevitably will come, so we should save an emergency fund to prepare for them.

How much should I put in my emergency fund?

The amount you should have in your emergency fund will be unique to your specific situation. Factors such as your household income, job stability, and other financial goals all come into play.

Remember when we created your budget? The fixed expenses you identified there will help guide you on the amount to keep in your emergency fund.

(We’re not concerned with discretionary or fun spending in an emergency situation. We’re just trying to survive.)

Typical advice says to have 3 to 6 months of expenses in your emergency fund, but your fund can be as little as 1 month of expenses to as much as 1 year or more.

Let’s look at a few examples to help flesh this out.

Two-income household with stable jobs

If you are in a two-income household and both of your jobs are pretty stable, you’d be okay on the lower end of the spectrum (3 months of expenses).

This is especially true if you have extra money left over at the end of the month after all of your expenses are paid.

If you are trying to pay off debt, you may wish to have a slightly smaller fund (1 or 2 months) while you complete this goal. This is because having money in savings while you have debt is effectively like borrowing money at the interest rate on your debt to put into a savings account.

Mr. TMG and I fall here. We want to pay off our debt as quickly as possible, so we have a slightly lower emergency fund. We currently have 1 month of expenses in our emergency fund, but we also keep our expenses much lower than our income.

The leftover money generally goes to extra debt payments, but if an emergency were to come up, we could decrease the extra debt payment to cover it. We plan to bump our fund up to 3 months of expenses once our debt is paid off.

Single-income household with a stable job

If you’re single, you’d want to have a bit more in your emergency fund because you wouldn’t have a second income to fall back on if you lost your job (assuming you don’t have a side hustle).

You’d probably be fine in the low to mid-range (3-6 months) if your job is fairly stable.

If you’re trying to get out of debt like we are, you may decide to stay on the lower end (3 months) while you work to pay the debt off quickly.

If you’re debt free (congratulations!), you may decide to keep more in your emergency fund (6 months or so).

Single-income and less stable job

If you’re single and your job is less stable—for example, you own your own business, work as an independent contractor, or work in a field that’s volatile—you’ve got the highest risk of an emergency devastating your finances. This is because (1) you don’t have another income to fall back on, and (2) your income is unpredictable.

In this situation, you may want to keep your emergency fund balance on the higher end of the spectrum (6-12+ months).

Where should I keep my emergency fund?

Your emergency fund should be in a safe account that you can access quickly, but not so easily that you’re dipping into it often. Keep your emergency fund in a separate bank from your regular checking account, and don’t link it to your debit card.

Some people recommend investing your emergency fund because it’s not keeping up with inflation sitting in a bank account. While I understand the logic, I disagree with that recommendation.

It may be true that the returns from a bank account won’t keep up with inflation, but it’s also true that a bank account is not volatile like an investment account.

Your emergency fund is your safety net. It’s not meant to be an investment vehicle. In the event of an emergency, you want the funds to be there.

Think back to the Great Recession. The market dropped 56.4%, and this drop was accompanied by widespread layoffs and hiring freezes.

If you were affected by the layoffs or hiring freezes and had your emergency fund invested at that time, you would have lost a huge chunk of your money right when you needed it the most.

We keep our emergency fund in a Sallie Mae money market account. Fund transfers take about 3 days, but there’s usually at least a short lead time before you actually need funds in an emergency, so we’re okay with that.

Other popular online banking options include Ally and Capital One 360.

How do I fund my emergency fund?

If you don’t have an emergency fund yet, all of this information may seem overwhelming. No worries, friend.

You don’t have to go from $0 to fully funded emergency fund overnight. Take it one step at a time.

Remember that budget? (I told you it’s the key to your financial success.) Use any extra money left over after your expenses are paid each month to build up your emergency fund to your desired level.

You can accelerate your savings further by cutting expenses, taking on one or more side hustles, or both.

Whatever you do, I recommend saving at least a small emergency fund before moving on to other financial goals. Being prepared will turn a potential financial nightmare into a mere inconvenience.

Do you have an emergency fund? How has having or not having one impacted your life?