Emergency Fund: What it is, How Much to Save, and How to Create it

When was the last time something did not go as planned? What happened? How did you adjust? 

Life happens. 

Things go awry. 

We create contingency plans for when Plan A does not work. 

Spare tires in your car. Extra keys for your house. Uploading precious photos to the cloud. Additional food when hiking. Fire extinguishers in the kitchen.

Emergency fund

We don’t plan on using any of it. In fact, we hope to never use it. 

Yet, we keep it there in case something goes wrong.

What is an Emergency Fund?

An emergency fund is money set aside specifically for unexpected events. It’s the cushion between you and life when life decides to hit you over the head. 

What Qualifies as an Emergency?

Emergency funds are not for funding everyday expenses. They are meant for when life really hits you over the head, such as:

  • Job loss
  • Medical emergency
  • Unexpected home repairs (pipe bursts, roof leak, etc.)
  • Car accident
  • Travel emergency (sick relative you need to visit)

You should not use your emergency fund for large expenses that can be planned. For example, if you pay your car insurance every six months, you should be setting aside funds on a monthly basis – not dipping into your emergency fund. 

If you are unsure what qualifies as an emergency, ask yourself, “If I don’t buy this, what happens?” If something terrible happens, it’s likely an emergency. 

For instance, if you lose your job and don’t buy food, you are malnourished. If you don’t buy a plane ticket to visit a sick relative and they die, you may blame yourself for the rest of your life. If you get in a car accident and don’t repair your car, you may not get to work and lose your job. 

These count as terrible consequences.

How Much to Save in Your Emergency Fund

This is one of those hotly debated questions by financial experts. Is it 3 months of spending? 6 months of spending? 12 months of spending? 

The truth is – it depends! 

People dislike that answer, but it’s the truth. 

I’ll give you a few ways to think about how much is appropriate to save in your emergency fund based on your individual circumstances. 

Generally, if you have a stable income with good job security, most people will say your emergency fund should be 3-6 months of living expenses. If you have a variable income with less job security, most people will say your emergency fund should be 6-12 months of living expenses. 

For example, if you need $5,000 each month to pay for housing, food, health insurance, car, etc., you may want to keep $15,000 in a separate savings account as an emergency fund. If you feel more comfortable with 6 months worth of living expenses, you should keep $30,000 in your emergency fund. 

I tend to be more conservative with emergency funds. I personally think 6-12 months gives people more peace of mind. 

For example, even people with stable incomes and good job security, such as doctors, lost their income overnight during COVID-19 and were without income for a few months. If someone only held 3 months worth of living expenses, they likely were feeling anxious given the uncertainty around COVID-19 and when the U.S. would open again. 

They may not have needed more than 3 months worth of living expenses, but when they lost their income, I can almost guarantee people who had 6 months of living expenses felt much better the day they lost their income than those with 3 months. 

Those extra few months gave peace of mind during uncertain times. 

Emergency Fund: Peace of Mind

It’s similar to when I hike, I bring the equivalent of an extra bottle of water. 

Why? I never know what is going to happen.

If something goes wrong, I don’t need to immediately panic. The extra water provides flexibility. 

I think many people are re-evaluating their emergency fund after this year. For example, if you lost your job, how long does it take to find a new job, go through the hiring process, and get paid? For most people, it’s going to be over a month on the best timeline. That leaves two months of buffer. 

What if the economy is terrible and nobody is hiring in your field? How stressed would you feel? How would you feel looking at your bank account knowing you have to get paid within the next two months?  

The amount in your emergency fund also depends on your comfort level with risk. As I mentioned, I’m a conservative person when it comes to finances. I like having 12 months of cash on hand. It’s excessive for most people. 

Though it is not earning much and losing to inflation, it allows me to sleep better at night. I know if something happened with my job tomorrow, it would provide me the leeway to find another good position without feeling rushed into a role that was not a good fit. 

It’s impossible for me to put a dollar figure on that feeling.

You’ll need to decide what works best for you. At a minimum, consider working up to 3 months worth of living expenses. For some people, 6-12 months may make more sense. 

Where to Keep Your Emergency Fund

You’ve decided you want to build or adjust your emergency fund. Now what? 

Where do you keep it? 

Keep it in a separate savings account at your bank. If you are looking for something with a higher rate of interest, consider an online savings account like Ally.

Why should it be separate?

It should be separate from your other savings because you want to easily identify it. If it is mixed in with everything else, it muddies the water. You want the clear distinction. 

Emergency funds should not be invested. You don’t want the money at risk. 

What about a Certificate of Deposit (CD)

Perhaps for a portion, if it is a no-penalty CD, meaning you can withdraw funds without a penalty. 

Personally, I don’t like complicating the emergency fund. Make it as simple as possible – cash at the bank in a separate account. It’s simple. It’s easy to access. 

How to Create Your Emergency Fund

Now that you know you want to create an emergency fund, how do you create it? Money is not going to magically appear in your account. 

Slowly. You build it slowly. 

You need to understand your cash flow. What goes in your bank account each month? What goes out?

From there, start making small changes. Once you have the separate emergency fund open, create an automatic transfer into it at the start of each month. Start with an amount you don’t think you will notice. That might be $5, $10, $100, $500, $1,000, or $5,000. Each person is different. 

Try that for a month or two and gradually increase it until you start to notice. For example, If you started at $10, try $15 the following month, and then $20. Continue increasing the amount until you start to feel it in your budget. 

You are always paying yourself first with this method. That is really important because it makes building an emergency fund a priority. You will likely adjust your other spending if the money is not in your checking account available to spend.

As you fine tune the amount you save each month, determine what the “normal” amount will be and determine how long it will take to reach your goal. For example, if you need $15,000 and you are saving $1,000 a month, it will take about 15 months to reach your goal. Continue monitoring your progress and adjust as necessary. 

Life is not a straight path. Don’t be surprised if you need to increase or decrease the amount. 

If you have a credit card or other high interest debt, consider this same strategy, but instead of creating an emergency fund, use the amount you would be saving to pay down the debt.

In most cases, it does not make sense to pay 15% or higher interest on a credit card and save into an account paying you less than 1%. 

Emergency Fund: Real World Examples

The emergency fund concept is great, but let’s explore a few real-world examples to make it more concrete. I’ll share two from my own life. 

Skin cancer runs in my family. Because of that, I see a dermatologist every year for a skin check.

Not-so-fun-fact: skin checks are not preventative care, meaning your insurance may not cover it, and you might need to pay out of pocket.

A couple years ago, I had two irregular moles. The dermatologist suggested removing and submitting them to the lab for a biopsy. 

I consented. The labs determined the moles were non-cancerous. That was the good news.

The bad news came in the mail a few weeks later. The bill for the visit, procedures, and labs was over $800. 

Thankfully, I had money in my emergency fund for these types of situations.

The second example happened a few years ago. My mom was vacationing in Palm Desert to escape the Pacific Northwest winter for a couple weeks and became ill. 

After a few days of being sick, she was admitted to the hospital. 

They did not know what was wrong with her. After deciding whether I or another family member should come down, I decided to book a flight for that afternoon. 

For anybody who has spent enough time in hospitals, you probably know how important it is having an advocate in the room with you. I strongly believe someone should have a family member or friend with them while in the hospital. 

They don’t need to be there 24/7, but they should be there for the important conversations. They should voice their concerns, ask clarifying questions, and ensure their loved one is being taken care of. When someone is at their weakest, they are likely to forget the key things or ask the right questions. 

Because of this, I felt I needed to fly down the same day. 

I had never booked a same-day ticket. I was always under the impression they are dirt cheap because the airline is trying to fill seats. 

I was wrong! 

They are very, very expensive. The flight was two to three times more expensive than normal. 

After choking at the cost, I booked it and was on my way. After a week in the hospital, we flew home together for her to finish recovering at home. 

This was an emergency I never expected. 

Fortunately, my job allowed me the immediate time off, and I had funds available. Though my mom later reimbursed me, I did not know that would happen when I booked the ticket. Having funds set aside for this type of emergency made it easy to book the ticket without worrying.

It’s hard to imagine stressing over the finances during an already stressful health situation.

It’s important to have an emergency fund ready for these types of situations. 

Life will take you on the windy path. The emergency fund helps put you back on track.

Taking Action with an Emergency Fund

Emergency funds are easy to ignore. 

After all, emergencies don’t happen on a daily basis; however, you will be calmer and less stressed if you have one the next time you face an emergency. 

If you don’t have one open, consider opening one! 

If you have one, revisit the amount. How many months’ worth of living expenses makes sense for your situation? Will it cover that many? 

Emergency funds provide peace of mind in times of stress. 

I’ve seen how it has helped others. I’ve also personally experienced it. Do you want that flexibility? You can work towards it.

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for Full Disclaimer

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