What is an Emergency Fund?
An emergency fund is money held in designated bank account earmarked only for urgent crisis situations. Some examples of these include:
Sudden car repairs (if you need your car for you job, to access food, etc.)
Home repairs, especially ones that cannot be postponed or affect safety/habitability
Medical bills or healthcare expenses for immediate, serious treatment
Loss of income and/or healthcare benefits
Keep in mind that when discussing an emergency, everyone's situation will be different. However, please stick to its true definition: "a serious, unexpected, and often dangerous situation requiring immediate action." For example, a spontaneous fun weekend trip with your family is not an emergency. However, a sudden trip to see loved ones due to an illness, injury, death, or other unexpected crisis would be considered an emergency expense.
Why are Emergency Funds Important?
Life happens. Just within the last few decades, we've weathered economic downturns, a pandemic, job losses, medical emergencies, car breakdowns, and other situations with unexpected costs. If your plan for these situations is to take out a loan or use your credit card (without paying off the balance), that emergency will likely cost you high interest.
Where Should I Keep My Emergency Fund?
Ideally, in an account that is safe and readily accessible. (So ideally, not under your mattress.) For those who struggle with mindful spending, it might also help to keep it in an account that takes a bit more effort to access. I like using my credit union since it's local. However, if you are often traveling, it might make more sense to use an online account such as Capital One.
NOTE: If you are in a dire situation such as living with an abusive spouse or family member, cash or a prepaid debit card might be your only options. Keep in mind that these can be stolen or destroyed. If you can't find a safe place at home, find a trusted friend or family member to safeguard it.
How Much Should I Keep in My Emergency Fund?
I've heard many numbers suggested over the years, from $1,000 to a few months' worth of expenses, all the way up to 1-3 years' worth. Think about the most common emergencies you've dealt with in the past, and how much they cost you. You should also consider other factors that you may have never faced, but that are within the realm of possibility. (For example, a tornado hitting my home has never happened, but I'd like to have a plan in place in case it happens.)
Personally, I love Rachel Richards' recommendation of calculating 4.5 months of living expenses and aiming for that number. In her book, Money Honey, she advises having this amount available as a secondary emergency fund in addition to a primary $1,000 one.
For example, if your monthly living expenses are $5,000 per month, then that amount multiplied by 4.5 months would be an emergency savings goal of $22,500. I feel comfortable with this recommendation since 4 months is about the longest it has taken me to secure a job after a layoff, and the dollar amount would more than cover various emergencies I've experienced in the past.
Whatever number makes the most sense to you, I encourage you to aim for $1,000 at minimum.
I Don't Have an Emergency Fund. Where Do I Start?
Decide on your Emergency Fund goal number.
Pick where your Emergency Fund will be: credit union, online bank, on a prepaid debit card, etc.
Start small. If small for you is $5 per month or $500 per week, stick to that until you reach your goal.
If you can, automate your contributions. Make life easy on you.
When you hit your goal, either come up with a new savings goal or divert the extra the funds elsewhere (such as another savings account or investments).
I've Reached My Emergency Fund Goal. Now What?
Treat your emergency fund like a stranger in public: under no circumstances should you touch that stranger unless it is an emergency. Practice health boundaries here. If that fund is earmarked for emergencies, then do not access it unless you meet one of the crisis criteria listed above.
I'm Sooo Tempted To Spend My Emergency Fund on a Non-Emergency Expense
Pause, take a few deep breaths, and do some reflective work. What's coming up for you that makes the expense feel so important? Is it FOMO (fear of missing out)? Do you fear disappointing someone or letting them down? Does the sense of urgency match your current reality?
I encourage you to sit down and write out some guidelines for what you deem an emergency for you. Consider why that boundary is important to you. What are you protecting? (Your health, peace of mind, children, etc.)
I've Dipped Into My Emergency Fund and Now I Feel Stressed. What Should I Do?
Again, pause, breathe, and sit down to reflect. Whether you dipped into your emergency funds for a true crisis or a nonurgent expense, it's important to evaluate what you need, how you'll get there, and how you'll stick to your money boundaries.
If you used your earmarked emergency funds for a true emergency, then you practiced healthy financial boundaries. Unfortunately, your stress is now double because (1) you have a smaller emergency fund and (2) you are now likely recovering from whatever crisis just affected you. Focus on self-care within your means and ability. Reach out to your support network. Try to remind yourself that life has ups and downs. Things will eventually get better.
If you used your emergency funds for a nonemergency expense, own the stress. There is no way around the negative feelings (guilt, shame, etc.) except to just feel them. This is a healthy part of accepting your actions, the consequences of your actions, and reinforcement for doing better in the future. If you need to, please use the suggested writing exercise in the previous section.
If I Keep Going, Is Over-Saving a Bad Thing?
Maybe. I don't want to tell anyone that saving is a bad thing, because inherently it isn't. But if your goal is to build wealth, consider the potential loss of saving money in a low-yield savings account (say, less than 2% annually) versus investing it with a potential return of 8% annually.
Hopefully, having an adequate emergency fund will alleviate enough stress that you'll be in a better mindset to identify your FIRE and/or other money goals.
Feel free to share your thoughts and recommendations on emergency funds in the comments section!