Now, I do have car insurance, but since I couldn’t bill against the perpetrator’s likely non-existent insurance, I had to pay for my $1,000 deductible, unfortunately. Thankfully, aside from the inconvenience of it all, the incident didn’t worry me from a financial perspective—because I have an emergency fund.
Here’s what we’ll talk about in this article:
- What Is an Emergency Fund?
- How Much Money Should I Have In My Emergency Fund?
- Where Should I Store My Emergency Fund?
- When Is It Acceptable to Use My Emergency Fund?
- Closing Thoughts
What Is an Emergency Fund?
Emergency funds are, as the term suggests, funds for covering emergencies. There’s more to them than that, however. Here I will discuss everything you need to know about emergency funds, while also conveying the importance of having one.
How Much Money Should You Have in Your Emergency Fund?
To be safe, you should keep at least three-to-six times your average monthly expenses in a high-interest savings account dedicated as your emergency fund. In most cases, three-to-six months’ worth of expenses is sufficient to cover emergencies such as abruptly losing your job, a major car repair, or a small medical incident. If you’re unsure of how much your average monthly expenses are, I can show you how to create your monthly budget.
Where Should I Store My Emergency Fund?
You may notice that I specified in the last section that your emergency fund should be in a dedicated savings account. If you’ve read our article on the power of investing, you may feel now that throwing all of your saved money at investments is the best move that you can make, as doing so will generate the most wealth for you over time. While this is generally true, this advice exists beyond funding your emergency fund. You’re much better off with your emergency fund being housed in a savings account—not a brokerage account—because of two important things: liquidity and stability.
Sure, by having less money invested in stocks or bonds, you’re theoretically reducing the amount of money you could earn via investing, but that’s missing the point of an emergency fund. Your emergency fund not a wealth-creation tool, it’s a wealth-preservation mechanism.
Imagine the case where you invest your $10,000 emergency fund in some hot tech stocks that, after a bad six months in the market, are now only were $5,000. Around this time, you drive over a massive pothole and snap a lower control arm on your car’s suspension, which is going to cost you $3,000 to repair. You’re forced to sell your stocks at their relative low point and, in a sense, that repair really cost you $8,000 ($3,000 repair + $5,000 lost in your investment), rather than just the $3,000 for the repair. Ouch.
When Is it Acceptable to Use My Emergency Fund?
I cannot emphasize this enough: only use your emergency fund for emergencies. It’s too easy to become interested in an expensive purchase and look to your emergency fund as an easy way to fulfill that want. In this sense, an emergency is anything unforeseen that falls outside of the scope of any of your monthly budget’s categories, including your dedicated “miscellaneous” category. Save your three-to-six months of expenses in that account, then don’t even think about that money.
Closing Thoughts
The idea of tying up several thousand dollars in an account that produces very little interest may be frustrating, especially at the beginning of your wealth-building journey, where every dollar makes a significant difference. Trust me—you’ll be glad that you set that money aside; emergencies always appear, and if your experiences are anything like mine, emergencies like to introduce themselves at the worst times.
If you’re wondering where to open your dedicated savings account, I recommend Ally Bank, which is a fully online bank offering impressive interest rates and a great mobile app for interacting with your account. As of September 2023, I earn 4.25% interest per year on my emergency fund, which is stored in Ally’s traditional “Online Savings” account (note: not an affiliate link). Ally’s accounts are completely free and definitely worth checking out.
Explorers, have you been in a situation where you didn’t have an emergency fund when you really wished you had one? If you already have one, how many months’ worth of expenses do you have in it, and which bank do you use?
