Shit happens. It’s an unfortunate truth to life we’d all love to escape but can’t. It’s as inevitable as death and taxes. While we can’t stop life from curb stomping us, we can put an insurance policy in place to protect ourselves in these situations—an emergency fund. Learn more about what an emergency fund is, why it’s important to have one, how much you should have in yours, where to keep it, and how to save up for it below.
- An emergency fund is a dedicated amount of money set aside for when shit hits the fan.
- Having an emergency fund reduces stress when Murphy’s Law kicks in your door and saves you money by eliminating debt interest payments or costly panic decisions.
- Your emergency fund should cover 3 to 6 months of expenses (not income) or your deductibles.
- Don’t invest your emergency fund. Park it in a high-yield savings account offered by a different institution than your primary checking and savings accounts.
- To save up your emergency fund, budget every dollar you have left at the end of the month past required expenses until you’ve saved up your target amount.
What is an emergency fund?
An emergency fund is a dedicated amount of money you set aside that you encase in metaphorical glass that has a “pull in case of dumpster fire” lever. It’s usually kept in a completely separate account from your checking account so you don’t dip into it for your weekly night out for tapas and tequila.
An emergency fund helps with situations such as:
- A job loss
- Unexpected medical issues
- A broken air conditioner
- A broken down car
An emergency fund is not a rainy day fund. Your emergency fund is the “oh shit, a hurricane has parked itself over me and it’s been raining nonstop for six hours and the water level is getting really close to testing how airtight my front door is” fund.
Why is it important to have an emergency fund?
Your emergency fund provides you peace in chaos.
If you’ve seen Ice Age, think of your emergency fund as Scrat’s elusive acorn. It’s a life giving item that can feed you in dire circumstances. It’s purposefully difficult to get to and even harder to catch and grow when you’re coming out of a personal finance permafrost. But when you have one? It’s heaven. When you don’t? You dream of it.
Your emergency fund reduces stress.
Murphy’s Law states “Anything that can go wrong will go wrong, and at the worst possible time.” We’ve found this to be true. The only time the propane tank malfunctioned in an Airbnb rental was the weekend Blue Ridge expected a high of 8F and iced roads. The car window broke when the flu laid my husband out for two weeks.
Emergencies are never convenient, but they can be pesky annoyances versus Chicken Little’s “the sky is falling!” if you have an emergency fund to provide margin in your personal finances.
Your emergency fund buys you rational thinking when things inevitability break.
If your car breaks down, you are much more likely to panic and go out and get a new car loan—and to roll in negative equity—if you don’t have an emergency fund to cover repairs. If you have an emergency fund, you have the time to pause and assess if it’s better to repair or replace the car, instead of immediately going out and financing a new car on a death interest rate because you don’t see another option you can afford.
Your emergency fund saves you money.
Unless you’re Raising Hope in a busted up car that has a death trap hole for your kid to fall through, it’s usually cheaper to repair your car than replace it. Trading in a broken car for a new one puts you further into debt on a vehicle that goes down in value.
If you don’t have an emergency fund but finance the repairs on a credit card, you not only have to pay for the repairs, but 20%-30% interest. For a $3,700 car repair like our blown A/C compressor, that’s about $75 additional each month you carry the balance.
Your emergency fund can keep you out of debt.
If your needs are close to 50% of your budget, you’re likely feeling the squeeze of debt in your life before an emergency even strolls past your house. Adding more debt will increase the stress in your day-to-day finances, not just the stress of the moment.
By having an emergency fund, you have margin while working hard to become debt free. Once you’ve completed your debt-free journey, your emergency fund is an insurance policy to make sure you never go back into debt again.
How much should I save for an emergency fund?
How much you should have in your emergency fund depends on your situation. Two common guidelines in the personal finance realm are:
- 3 to 6 months of your expenses (not your income)
- enough to cover all your deductibles
Dave Ramsey is king of the 7 Baby Steps, which also distinguishes between a starter emergency fund and the fully funded emergency fund. Under Dave Ramsey’s guidance, you would keep an emergency fund of $1,000 to cover minor emergencies while working your way out of consumer debt, then beef your emergency fund to 3 to 6 months of expenses.
We don’t like this approach, as $1,000 isn’t enough to cover a lot of emergencies, especially if you’re a homeowner. Dave Ramsey himself admits this is true and claims it isn’t supposed to be enough. He thinks the knowledge that it isn’t enough will motivate you to get out of debt faster.
While we’ve heard cases where this is true, we’ve sadly heard the opposite as well. If you have an unexpected $5,000 home or car repair situation and only have $1,000 in your emergency fund, you’re much more likely to go back into debt to survive, which can cause your debt snowball to melt on the spot. Some people find themselves in an even worse financial situation with more debt than when they started on their debt-free journey in these situations.
If you’re going to have an emergency fund, go big or go home and pray nothing breaks.
3 to 6 months of expenses
For your 3 to 6 months emergency fund, remember this is your expenses, not your income.
But if I’m doing a zero-based budget like you recommend, aren’t they the same?
No, because your zero-based budget includes investing for retirement, saving up for future expenses such as car and vacations, and all the fun entertainment you have budgeted for your wants category.
In an emergency situation, such as a job loss, you won’t be taking a vacation when you have to dip into your emergency fund. You won’t even be thinking the word vacation. You’ll be running a bare bones budget as the Budget Beagle calls it, covering the expenses you need to survive until you’re through a The Day After Tomorrow storm. These expenses include:
- Insurance monthly premiums: health, car, life insurance, homeowners/renters, car, etc.
- Rent or mortgage payment (including escrow or prorated sinking fund amount)
- Utilities: electric, water, gas, internet, phone (in an emergency, pause your subscriptions)
- Food & household expenses: this does not include trips out for our beloved waffle fries at Chick-fil-A. This is enough to get by on ramen and rice at Wal-Mart.
- Minimum payments on debt
- Childcare expenses
Should my emergency fund be 3 months or 6 months of expenses?
This depends on several factors. While no job has true “job security,” some are more stable than others. For instance, a salaried person knows what their monthly income is (unless they get laid off or fired) while self-employed individuals or individuals who work on commission have less reliable income. In these situations, we recommend a 6 month emergency fund. In fact, if you’re an entrepreneur preparing to start your own business venture, we recommend closer to 12 months for this season.
We recommend leaning toward 6 months of expenses if:
- you have less risk tolerance and sleep better with a bigger emergency fund (like me)
- you have chronic health conditions
- you are in a highly specialized field with higher pay and where it may take longer for you to land a new job
- your household runs on a single income
- you own a home
- you have enough kids (or pets) to cast a production of Snow White and the Seven Dwarfs (the more kids you have, the more emergencies tend you find you)
- you have a lot of debt
- you have a baby on the way
Covering your deductibles
If you want to take the “cover your deductible” route, or want to consider your deductibles into figuring out what your emergency fund should be, count these toward your total.
- Medical deductibles (we would actually recommend the out-of-pocket maximum instead of the deductibles, as medical emergencies can involve hospital visits that quickly knock out your deductible while bills still thunder in)
- Auto deductible
- Homeowners deductible (remember, many policies have two deductibles – one flat amount and another hurricane/etc. percentage deductible)
Which method do you use in your household?
At The Budget Brigade headquarters, we use the 6 months route. In all honesty, since we’re high on the FIRE ladder, we have about 6 months of actual expenses, including investing, so that we can stretch it into a year if we needed to really go lean in an extreme situation. There are a few reasons for our personal decision:
- We’re already debt free and saving 25% of our income toward retirement, so we have some flexibility in our wants and savings budgeting categories
- Unlike my husband, I have a very low risk intolerance
- I grew up in some financial instability, so having a fluffy emergency fund helps quiet my anxiety and lets me sleep better
- I’m an intrapreneur with entrepreneurial dreams as well, and my husband’s industry is rather unstable compared to many others, so we prefer having a buffer just in case
- If one of us were to suffer a job loss, we’d like the opportunity to take a mini retirement before landing a new position, since that resets the PTO clock for planned vacations
Where should I keep my emergency fund?
As mentioned above, your emergency fund is for only “the sky is falling, the sky is falling!” situations. It isn’t for a flat tire on the side of the road that you can cash flow by adjusting your monthly budget.
We like to avoid touching the emergency fund whenever possible (without debt!), so we put roadblocks in place to make it difficult to get to ours. As James Clear writes about in Atomic Habits, make the bad habits difficult while incentivizing good habits. By making the emergency fund a pain in the ass to access, it makes us less likely to dip into it on a rainy day that we can easily cover.
A few recommendations on where to stash your emergency fund:
- Set it up in a different institution than your primary checking/savings account so you don’t have same day transfers
- Don’t have a linked debit card or checks that allows you to easily withdraw funds
- We prefer a FDIC insured high-yield savings account
But wait, aren’t you always telling us not to lose out on the opportunity of compounding growth?
Yes, we are—for your retirement investing. Your emergency fund isn’t part of your retirement planning, it’s your safety net for the disasters of tomorrow, not financial independence to retire early in twenty years. The goal of your emergency fund isn’t to grow as much as possible, it’s to stay as safe so that when you have an emergency, you’re covered.
Do not invest your emergency fund in the stock market, crypto, or any other idea you might have to make money off your emergency fund. Park it in a safe, insured account. We do, however, prefer a high-yield savings account versus a traditional one, as we’d like your emergency fund to keep up with inflation as close as possible. Otherwise, you’ll have to budget to increase your emergency fund as the everyday prices of your expenses (hello, groceries) increase.
How do I build my emergency fund?
Time for our favorite word around here: you budget for it!
Once you’ve determined your financial goals (rung one of the FIRE ladder) and assessed your current financial situation (rung two), it’s time to fortify your fire station, including getting an emergency fund in place.
Put together a zero-based monthly budget. Any spare dollar you have coming in during the month, allocate to building up your emergency fund. At the end of the month, when you zero out your final expenses, take any additional money you budgeted for but didn’t spend and add that to your emergency fund sinking fund as well. Then transfer that amount to the account you set up for your emergency fund.
Do this every month until you hit your emergency fund goal amount.
If you’re competitive AF and/or like marking things off lists or making visuals to keep you motivated, consider drawing or printing out a visual representation of your goal and marking off the benchmarks (such as every $100 or $1000) as you save up to keep yourself motivated. Our alma mater used a thermometer every year during their annual giving drive. Pinterest is a great site to explore for ideas.
Not having an emergency fund is an emergency in itself, so minimize your expenses as much as possible and consider adding additional income for a season with a side hustle while you build up your “oh *&@!” fund. We recommend a bare bones budget in this season of your life. There are plenty of free or frugal fun things you can do so that you don’t hate your life but can accelerate your journey up the FIRE ladder.
Final Thoughts
We hope this covers all your questions about building and using your emergency fund. If you still have questions, drop us a line in the comments below or post it in our budgeting and personal finances Facebook group for the hive mind.