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I’ll start off by saying an emergency fund should be your first savings goal. Plain and simple.
When I first went out on my own, I didn’t know this. I was young and thought I was invincible. I didn’t think about emergencies and certainly didn’t think anything bad was going to happen to me. Then something did. I lost my job out of nowhere because of cutbacks and had to scramble to find a new one with barely enough to get by for a few weeks. Luckily, it was just a few weeks before I got a new job.
I got slapped in the face by a true emergency and had no safety net to catch me when I fell.
I learned my lesson…the hard way.
Most Americans don’t have enough savings to cover life altering events that could happen to anyone. In fact, around 45% of Americans don’t have even $1,000 saved. They are just walking around hoping they make it to the next paycheck.
You don’t, and shouldn’t, have to be a member of the broke 45%. In fact, you need to be a part of the exception with an exceptional emergency fund.
Short answer: It is money set aside…that is relatively easy to get to…in case you are faced with unplanned expenses or a financial emergency. Without one, you are walking a financial tightrope without a net. There is nothing but air and concrete beneath you.
It’s a cash reserve, in a savings account, that you can draw from when life throws you a curveball. It’s sometimes called a rainy-day fund. And whether or not you want to believe it, rain is destined to come and sometimes it pours.
Here are some of the emergencies you might face:
An emergency fund covers unexpected expenses that come out of nowhere. Things will happen in your life where you will need money that lies outside your budget (money plan).
An emergency fund is cash available, not available credit.
Credit cards or loans do not count when it comes to your emergency fund! Available credit doth not a fund make.
To put it simply, there will be a time in your life that you will need money to cover something you haven’t planned for. Not everything is under your control.
So, plan for it. Expect the unexpected and have money on hand to cover it.
Walking around with stress and anxiety is horrible, and terrible for your health. So is living with the nagging feeling that something bad just might happen and if it does, it would mean financial devastation.
Knowing that the unexpected is right around the corner, and having planned and saved for it, takes all the financial stress and anxiety away. It allows you to live a full life without financial worry.
If you don’t have enough money saved to cover the unexpected, and you are forced to use credit, it’s going to cost you. Big time. You will pay interest, and probably for a long time.
If you don’t have enough money to cover the emergency, then you don’t have enough to pay your card in full after you use it. Having the cash in hand when emergencies happen means you can pay for them in full without the added stress of being in debt.
If you are single and don’t have very many responsibilities, $500-$1,000. The same goes for a dual-income household where one income can handle basic needs for a while.
If you have kids, or other dependents, then one month’s worth of life expenses (just the basic needs to make it a month) is the way to go. You should also do this if your job is not steady and your inflow can’t be always counted on.
Then pay off any credit cards and high interest debt! (If you have any. If you don’t, then go straight to long-term.)
Most of the advice and guidance out there says save 3-6 months’ worth of living expenses.
I say, buckle down and go for the six months’ worth of life expenses. Just the basics to survive for six months if something drastic happens.
Note to my kids:
You could also save six months’ worth of your life expenses and living money (total budget less savings and investing) if you don’t want to give up anything while you recover.
This includes stuff like going out to eat, seeing a movie, etc.
This approach means you save a little more so you don’t have to put your life completely on hold in case something happens.
My advice is saving three months’ worth of your total monthly expenses, including the fun stuff, then start investing more. Once you have your investment plan in place, your savings should be focused on bringing this emergency fund up to six months.
When you get married and have kids, you should have six months’ worth already in place.
It will take some time, so don’t get frustrated. Just make sure you put your extra money towards your emergency fund, and you will see it grow. If you are super-focused, it will happen sooner than you think.
Your expenses will probably grow over time. Things will only get more expensive, not the other way around. There are things you can do to bring your expenses down, sure. But inflation is inflation and it’s out of your control. Look at the price of gas over the last few years.
You will need to go back occasionally and adjust your fund to match your expenses. That means you will have to add to it periodically.
If you are saving enough money to cover 3-6 months’ worth of expenses, then you need to know what those expenses are and what they total. You need to take a cold, hard look at all of the money you spend each month and figure out exactly what you need to survive if something really bad happens.
Pull out your bank statements for the last six months (you can easily do this online if you have a good bank) and highlight the basic things you need. This includes your rent/mortgage, utility bills, car payments, fuel, groceries, etc. These are the have to haves. In your money plan, these will be your life expenses.
Take the averages over the last six months, and then you will find a pretty close to dead on estimate of what your basic needs are.
A simple way to do this is by using budgeting software that auto imports your accounts, like Quicken, Simplifi (app only) or YNAB.
(Simplifi is a great app where you can do everything on the fly. Quicken is a great all inclusive web-based application that you use primarily on your computer. YNAB is a little more complicated, but pretty powerful.)
Now that you know what you need each month, it’s time to figure out what your savings target is. This is when you decide whether or not you want to shoot for three months or six months, or maybe something in between.
This is also when you decide if you want to save to cover your total monthly expenses, or just to cover basic living expenses.
One thing you could do is focus on just basic life expenses and throw everything you can towards your emergency fund until that goal is met. Then you can slowly add to it until your total monthly expenses are met. In essence, two goals with two different saving approaches.
Take a look at your bills and see where you can cut back.
Find out ways to lower your utility bills. Maybe change your phone plan. Try going without cable until your goals are met. If your lease is up, consider moving to a place that is lower rent.
There is money to be found if you really look for it.
This is where extra money can really be found.
Try living as basically as you can until you reach your goal. I’m not saying become a shut in living off of ramen and saltine crackers. Just ask yourself whether you really need something instead of want something.
Do you really need that designer handbag when you have a closet full already? Can you go without eating out twice to three times a week? Do you have to have the newest iPhone when what you have is just fine? Is the Barbie movie so groundbreaking that you have to see it in the theater?
Ask yourself…and be honest…do I really need this?
Here’s something I do. Whenever I see something I want and am about to make an impulse purchase, I take a breath, walk away and think about it. If I talk myself out of it, then I immediately take out my phone and transfer the money I would have spent into my savings account. I truly saved money by deciding not to buy it, so I put the money in savings.
Save that first $500-$1,000 (or a month if you have dependents, medical issues, or an unsteady job).
Then attack that debt!
Once you’re done, you will feel so much better without debt sitting on your shoulders and reaching for your wallet.
Now you can take all that money you were paying to the credit card companies and pay yourself instead.
And, oh yeah, stay out of debt from now on!
Focus all your attention on your emergency fund. This means putting off saving for cars, a down payment on a future home…everything. Once your emergency fund is complete, then you can start focusing on saving on short-term and long-term future wants and needs.
That being said, make sure you save for the life expenses that don’t happen monthly. Things like car registration, property insurance, etc. These should be built in your money plan, so treat these savings as bills.
Except for your 401K match, you should hold off a bit on investing. I know, I know…you’ll lose out a little on compound interest and you need to save for retirement. But you should not treat your retirement fund as your emergency fund. If you do have to use it because you have no other money, you will incur all sorts of penalties and it will set you back even further.
Take unexpected money and money outside your budget and put it in your emergency fund.
This money comes from tax returns, bonuses at work, raises, that birthday check from your grandmother, etc.
Anything above and beyond your pay, should go into savings.
This is the easiest way to start saving. If you receive your paycheck via direct deposit from your company, then they can usually allocate your pay to more than one account. Tell your company how much to send to your checking account and how much to your savings account. They can usually do this using a percentage.
If your company doesn’t offer this, then you can set up an automatic transfer between accounts inside your bank, online, or using your banking app. You can set these ahead of time as recurring transfers, so you don’t have to think about it. Set it for when you get paid and then forget it.
If you have some spare time on your hands and you are motivated to fund your emergency fund as soon as possible, then maybe you should pick up a side hustle. Just a little something you can do in your spare time to pick up some extra cash.
The best place to put your emergency fund money is in a high-yield savings account at a bank that is not your regular bank. This is important. Your emergency fund should be totally separate from your other money.
Why you should do this is twofold. First, your fund should be accessible, but not easily transferable to your checking account. This takes away the temptation to use it on a whim. Secondly, your emergency fund should be an “out of sight, out of mind” stash of money. Of course, you should check it periodically, and add to it if and when your expenses rise, but this is your safety net and should not be a part of your everyday finances in any way.
There are some great high-yield savings accounts out there, mostly offered by online banks. They don’t have brick and mortar expenses, so they can offer higher rates. Make sure the accounts they offer are insured by the FDIC.
Some great online banks to consider are:
Hopefully, never.
The problem is this rarely happens. Expect to dip into it sometime in your life.
The goal is to never touch it. Once you have funded it, you’ll be saving for other things, so you might have to take money out of those savings to cover an emergency and start funding them at a later date. You should be able to pass on your emergency fund when you pass away.
You should only take money out of your emergency fund if it is a true emergency. You should ask yourself a few questions when something unplanned happens:
Putting a new transmission in your car and it’s your only way to get to work might constitute an emergency, and you will probably have to dip into your emergency fund if you don’t have any other money available. Buying a new motorcycle because that hottie at the bar says she loves to feel the wind in her hair does not, in any way, constitute an emergency.
An emergency fund is absolutely crucial and should be your first savings goal. If you are truly dedicated, you can fund it quite quickly. If your life expenses are low and you are willing to buckle down and save assertively, then you will be surprised at just how quickly it can happen. That being said, it’s not an overnight endeavor. You might find it takes a year or two. But a year or two is nothing in the grand scheme.
Of course, if your life expenses are high, and you are struggling to save, it will take longer. But you can make some adjustments and find money somewhere. If you can only save a little at a time, that’s okay! Save what you can whenever you can. Cut down on eating out and save an extra hundred or two. Plan a staycation instead of a vacation. Pass on that sweater you think you just have to have when you already have 20 collecting dust in your closet.
You might feel that life is passing you by while you sit back and save. Don’t worry. Once it is funded, you will find out that life is even better. You can go back to saving for the things you want and spend on the little things you passed on while saving. You can take that vacation and truly enjoy it without that nagging feeling you are one emergency away from financial devastation.
The emergency fund is the first step towards financial independence.
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