Everything you need to know about Emergency Funds: Why, What, Where, and When and How.
Background of Emergency Funds
- 43.3% of Americans have less than $500 set aside for a financial emergency
- 34.5% of Americans don’t have an emergency fund at all, and 14.5% of Americans don’t even know what an emergency fund is. (Source)
This post is dedicated to that 14.5%. You know who you are. Or maybe you don’t. But maybe you can read this post, and then you can have the amazing honor of lowering that percentage. These types of statistics are what led me to start my blog.
Emergency Fund: A Primer
What is an emergency fund?
Exactly what it sounds like. Basically, it’s money that you put aside to help you cover emergencies. It is money that is set aside for life’s unexpected events.
Why is this different than other savings?
Because when we talk about savings, we usually are talking about money that you are investing in a way that will make you money. You want the money to grow. An emergency fund is not meant to be invested. You want it there when you need it. This means that you want it easily accessible. Think about a pile of cash that you can pull out in case of emergency. You want it readily available.
Of course, a pile of cash is NOT a safe way to keep money (although having some ready cash is always a good idea), but that is basically the point. I personally keep my emergency fund in a savings account that earns interest, but it earns very little compared to other accounts, and it has no penalty for taking the money out. There is a time and place for other savings- it’s all part of the savings ladder.
Why do I need it?
Because life happens. Cars break. People get hurt. Medicine needs to be bought. Jobs get lost. People die. People get very sick. Crucial appliances get broken. The list goes on. The more catastrophic losses in life are usually covered by insurance- most people don’t have the cash to cover rebuilding a house, for example, but the smaller things in life have to be covered by you. Of course, covering an insurance deductible or co-pay can also be an emergency.
The hardest thing about emergency funds is that the harder you find to save for it, the more you need it. Think about it- if you live paycheck to paycheck, you can’t actually afford ANYTHING else-let alone a flat tire. Once I was going through a long period of under-employment, I used my emergency fund to buy my son $20 worth of medicine. If you barely have the medicine to cover basic bills, then an emergency can really knock you down.
Recently, there have been hurricanes and wildfires that forced many to evacuate. Having money to pay for transportation, for alternate shelter, for equipment to secure property, generators, etc., can minimize the financial devastation that can be caused. Also, having money gives you OPTIONS. For example, you can choose not to stay in a public shelter or decide to evacuate if you are in a non-mandatory zone that is expected to be struck.
Why can’t I borrow money for an emergency if I need to?
Assuming that someone will lend you money (not always a given- even credit cards have a nasty habit of having pesky things such as credit limits or insisting on knowing that you have a way to pay them back so unemployment can get a card canceled), borrowing even small amounts of money from a private lender or credit card can spiral very quickly out of control. While you may get a bank-sanctioned loan for a low-interest rate, an emergency usually necessitates an unsecured loan that usually has very high-interest rates and fees.
The worst of these are Payday lenders, who charge ridiculously high-interest rates for small loans. If you have to borrow even the smallest amount from these kinds of lenders, you may spend years paying off the interest. Unfortunately, sometimes small emergencies can cause a vicious cycle of borrowing to pay off other loans and falling deeper and deeper into debt- all for a minimal initial amount! The best way to avoid this (easier said than done) is to avoid the initial loan in the first place.
You may be able to borrow from kind-hearted friends and family, but everyone’s resources and patience are limited, and they may not be able to lend you the money you need on the terms you need. After all, who says they have an emergency fund? Additionally, there is no quicker way to ruin a relationship than borrowing money that will be difficult to pay back. When weighing a good relationship versus saving money, I would pick the good relationship. “Neither a borrower nor a lender be,” but I would much rather be the lender, and I certainly don’t want to be the borrower.
Where should I keep this money?
The best place to keep an emergency fund is in a regular checking or savings account. As long as you have an easy way to access the cash (checkbook or debit card), then you should be ok. I sometimes put an “emergency” purchase on a credit card and immediately pay it from my emergency fund. So you don’t need actually to have the cash in your hand.
It is good practice to have SOME cash in a safe, secure place to be used in emergency cases. I always suggest having at least a $20 bill in your purse or car to be used for gas or drinks or a lift if something goes wrong while you are out.
I personally use a CapitalOne360 Savings account for my emergency fund, but there are many other $0 fee banks that you can use as well. Only use a bank that doesn’t charge a monthly service fee or withdrawal fee (or that can be easily waived-such as signing up for e-delivery of statements). So many banks don’t charge fees that it is foolish to be paying for a bank account.
How do I start an Emergency Fund?
Just start. Take whatever money you can and open an emergency fund today. If you have a bank account that doesn’t require a minimum balance (no reason not to), then you can put $5 in and get started. Look around and see if any banks have any promotions for opening an account.
I started my CapitalOne360 account when they were having a promotion where they gave me $100 to start an account with $100 in it. That doubled my saving immediately and gave me the push I needed to continue filling my account (see, it’s easy!). Savings should come out of EVERY PAYCHECK. I put 10% of every paycheck into my emergency fund. You need money set aside every month towards this goal until you are finished.
It may take you a really long time to actually build your emergency fund, especially if emergencies crop up while you are trying to build it. If that happens- take as much as you need out of your account to cover it and then start over. It took me 5 years (!) to finally have ,000 in my account.
How much should I put in my emergency fund?
Your first goal should be to have $1,000 in your emergency fund. Why that number? It’s nice and big and round and not too big to be overwhelming or out of reach. Dave Ramsey recommends it, and it seems like a nice amount, so why not? I have found that $1,000 is about the amount needed to cover a broken appliance, a deductible, or car trouble. If you have an emergency that is more than $1,000 (it happens), then pay what you can- at least you’ll have that much less interest to pay!
An emergency fund’s ideal level is a full 6 months of living expenses- at least six months’ worth of money to tide you over. The theory is that if you are unemployed and bringing in absolutely $0 income for 6 months, you would not be evicted or starve.
It’s a large number and not an exact science, so you can make your own calculations, but it a good goal to start with. After you have a fully-funded emergency fund, you can start investing more in other more sophisticated accounts or assets. Theoretically, you could always liquidate those if things get really hairy-but that is a long, long way in the future.
When do I use my emergency fund?
Well, you can pray that you never have to, but chances are something will come up that you will have to dip into that fund. An emergency is a “serious, unexpected, and often dangerous situation requiring immediate action” An emergency is unavoidable. An emergency cannot be pushed off. An emergency could not have been foreseen in advance.
Obviously, it’s your money, and you can do what you want but keep in mind that these should not be considered emergencies: Regular Bills, vacation, Holidays (you knew they were coming), events such as weddings or babies, or anything you can save up for. Financial emergencies occur quite often and more often than you think!Having an emergency fund is one of the smartest things you can do for your financial stability and one of the concepts on which all personal finance experts agree upon Click To Tweet
Having an emergency fund is one of the smartest things you can do for your financial stability.
Don’t let an emergency derail your life and your future.
Don’t let a small thing ruin your life.
Don’t be stressed about how to pay for your kid’s medicine.
Build an emergency fund.
Have the small piece of mind that comes from doing your best to protect yourself and your family from financial disaster.
Are you clueless when it comes to your finance? The Basic Guide to Budgeting and Personal Finance will help you get started.
1 thought on “Everything You Need to Know About Emergency Funds”
Nice article. Easy to read and understand. Thanks for caring enough to share the concepts. Now, fellow readers, let’s get to work putting our emergency funds in place!