Do I Need An Emergency Fund?

There’s nothing fun about an emergency fund. It’s boring, it doesn’t grow a ton, and it just sits there. That is, at least, until disaster strikes. Then you’ll be glad you have that wad of cash buried in the backyard.

Yes, you need an emergency fund.

57% of adults in the US are unable to afford a $1,000 emergency expense, with 22% of adults having no emergency savings at all.

But instead of referencing statistics about some nebulous people somewhere, let’s make it personal. If your car takes a dump and you’re forced to fork over $1,000 to repair it, could you? Or would you have to charge it to your credit card, paying it back (plus an average credit card interest rate of ~20%) over time?

The reality is that emergency expenses have the potential to derail your financial progress if you’re unprepared for them, forcing you to take on additional debt through credit cards or personal loans as you throw a Band-Aid on the problem.

So yes, you need an emergency fund.

Let’s back it up for a second. What even is an emergency fund?

An emergency fund is simply a stash of money you have set aside in a savings account to handle the financial emergencies that life throws your way. This money has no other purpose than sitting and waiting for Murphy's Law to necessitate its use.

What constitutes an emergency that would warrant using this money? Job loss, medical emergencies, unexpected home or car repairs, unplanned essential travel, or even critical technology replacement (like a phone) are valid reasons to use an emergency fund. And no, Amazon impulse purchases or concert tickets aren't worthy of using your emergency fund, although Prime Day does hit different. On the flip side of the coin, you shouldn’t be afraid to use your emergency fund toward actual emergencies. That's why it exists.

How much money should my emergency fund hold?

In total, your emergency fund should hold enough money to cover 3 to 6 months of your current living expenses. If you spend $4,000 a month, that’s anywhere from $12,000 to $24,000 in your emergency fund. Why these numbers? On average, it takes about 5 months to find a job, with a range from 2 to 6 months.

The exact number you should save between 3 and 6 months will depend on two primary factors: your employment/income stability and your risk tolerance. There are no strict guidelines that will dictate this decision for you, but consider the following factors when determining the size of the emergency fund you want to build:

• Save closer to 3 months of expenses – When you have stable employment with a low chance of layoff, consistent income, you live in a dual-income household, you work in a field with numerous job opportunities, and/or you have a high tolerance for risk, you can save closer to 3 months’ worth of living expenses.

• Save closer to 6 months of expenses – When your employment is more volatile, your income varies month-to-month, you live in a single-income household, you work in a field with slim opportunities for employment, or you have a lower tolerance for risk, save closer to 6 months’ worth of living expenses.

Consider these factors when making your decision, but don't read these factors as a checklist that forces you into a decision that contradicts your instincts. The amount of money you hold in your emergency fund is a highly personal decision that can’t be reduced to a simple checklist.

Having a stable income and a high risk tolerance doesn't disqualify you from building a 6-month emergency fund. Em and I keep a 5-month emergency fund, although we have a higher risk tolerance and stable employment. You may find that a 4- or 5-month buffer is right for you. Ultimately, the amount of cushion you deem necessary and your confidence in handling financial stressors should drive your emergency fund's size. But whatever you do, don't save less than a 3-month emergency fund. Feel free to save for more than 6 months if the spirit compels you, but please note the lost opportunity of investing that additional money.

How should this money be saved?

Saving up an emergency fund of this size is no easy feat and can take some time. Instead of building your entire emergency fund in one push, you should accumulate this money in two distinct phases.

Your very first financial goal, before investing, debt paydown, or anything else, should be to save an initial emergency fund of $1,000 or the cost of your highest insurance deductible, whichever is greater. This initial buffer gives you room to get your head above water and breathe.

After you start investing up to your employer's match (if applicable) and paying off all moderate-to-high-interest debt you choose not to hold onto, increase your emergency fund to the full amount of 3-6 months' worth of expenses.

Building your emergency fund in two phases allows you to build an immediate cash safety net to defend against the ankle-biting expenses, take advantage of your employer's investment matching benefits, tackle high-interest debt, and then build a long-term emergency fund to handle bigger financial emergencies.

Where should I keep my emergency fund?

Great question, thanks for asking!

You want to keep your emergency fund in an account where your money is easily and quickly accessible without fees, has low to no volatility, and is earning some sort of interest, with little to no chance of your money ever losing value.

My favorite place to hold an emergency fund is a high-yield savings account, or HYSA. Most HYSAs allow you to access your money quickly without fees and have a higher return than traditional checking or savings accounts. The interest rates can fluctuate with federal interest rates, but HYSAs rates have historically never gone down in value. Most HYSAs are FDIC-insured, meaning the money you deposit in them is federally protected (up to $250,000). Since the origins of FDIC, no depositor has lost a penny of FDIC-insured funds.

Three of the best online banks in the business offering HYSAs are Marcus (the one I use), Ally, and M1 Finance.

For the hyper-aggressive investors who reject these options and can't possibly stand to see your money lose value to inflation, you can invest a small portion of your emergency fund in conservative investments in a taxable brokerage account while holding the majority of your emergency fund in an HYSA. But remember, your invested money will reap both the ups and downs of the market.

Isn't holding a pile of cash contradictory to the whole "let your money work for you through compound interest" thing? Wouldn't a significant cash holding diminish the value of your money over time to inflation? Yes to both questions, but the value you gain in security is worth the downsides.

Think of your emergency fund as the premium you pay to maintain financial stability and peace of mind. You gain peace of mind when you aren't living one missed paycheck or one personal emergency away from a negative bank account balance. Having a 3 to 6-month cash buffer affords you the additional freedom to live, work, and invest in a way that can be more advantageous for you.

Call to Action

If you don’t already have one, start your emergency fund by opening a high-yield savings account and throw $10 in there to get the ball rolling.

What We’re Reading/Watching/Listening To:

Podcast: Two Sides of FI. This podcast is hosted by two guys, one who has reached financial independence and the other still on the journey. They each offer interesting perspectives on personal finance and dive deep into the nuts and bolts of how to reach financial independence. It’s definitely worth a listen!

Debrief on Deck

Drumroll, please… Next week’s newsletter will be a Q&A, answering any and all personal finance related questions you have! Have a question that’s been nagging you but not sure how to find the answer? Give us a shot. Send us your questions through email or social media by Sunday, July 30th and we’ll answer as many as we can.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (Twitter, Instagram, Threads).

Until then, stay the course.

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