There were way too many years when I didn’t realize just how important an emergency fund was. I made enough money to pay my bills every month. But when an unexpected expense came up, I’d have to put it on a credit card or pull money from a different spending category.
Having a fully-funded emergency in place is seriously life-changing. It provides so much peace of mind and helps ensure that little bumps in the road don’t rock your financial world.
In this post, you’ll learn what an emergency fund is, how much you should have in your emergency fund, and how you can save enough money for an emergency fund.
What is an emergency fund?
An emergency fund, just like the name suggests, is a chunk of money that you set aside for an unexpected financial emergency.
Your emergency fund has two primary purposes. First, it can help to pay for unexpected one-off expenses that you don’t have room for in your budget. For example, if your car breaks down or you have an unexpected medical bill, your emergency fund can help to pay for it.
The other use for an emergency fund is a job loss. If you lose your job, your emergency fund can serve as a replacement to your income until you have a new job.
How much emergency fund should I have?
There’s a lot of debate as to how much you should have in your emergency fund. If you follow Dave Ramsey’s baby steps, he recommends an emergency fund of $1,000 until you pay off all your debt. Once your debt is gone, then he recommends that you save an emergency fund of 3-6 months worth of expenses.
Depending on how much debt you have, I don’t think $1,000 is nearly enough. When my husband and I got married, we were working to pay off about $150K of debt. We knew it would take us several years to get there, and I wouldn’t have felt comfortable going years with only $1,000 in our emergency fund.
My comfort level before paying off debt is about three months of expenses in our emergency fund. I feel confident that in our career fields, we’d be able to at least partially replace our income in that time.
Long term, I recommend an even larger emergency fund. I feel most comfortable with six months of expenses set aside for an emergency.
There are other things to take into consideration when it comes to the size of your emergency fund. If you’re single, you might want more of an emergency fund than someone in a two-income household who has another person to rely on in the case of a job loss. Similarly, someone who has children to support might feel most comfortable with a larger emergency fund than someone with no one relying on them financially.
Read More: Is it Better to Pay Off Debt or Save Money First?
People are tempted to underestimate how much they need in their emergency fun while paying off debt so as to avoid paying more in interest. However, the lack of an emergency fund can actually end up being more expensive.
Imagine you don’t have an emergency fund and end up needing a $1,000 car repair. Now you have to put the repair on your credit card, and in addition to paying the initial $1,000, you also have to pay the high credit card interest rate until you can pay off the balance.
Where should you keep your emergency fund?
It’s best to keep your emergency fund somewhere easily accessible and highly liquid. If an unexpected expense comes up, you want to be able to get to your money as quickly as possible.
A high-yield savings account is a great option. You’ll keep your money safe while earning a little extra money on interest. I personally recommend Ally Bank, but there are plenty of options that pay rates far higher than a traditional bank.
If you’re tempted to invest your emergency fund in the market, I highly recommend against it. The market can be volatile, and the last thing you want is for the stock market to drop at the same time you need to use your emergency fund.
How do I build an emergency fund?
STEP 1: DECIDE HOW MUCH YOU WANT TO SAVE
I talked about how much I recommend having in your emergency fund. But you’re the only one who can ultimately decide how much you’ll need. Once you know how much you want to save, you can figure out how long it will take you to get there.
STEP 2: FIGURE OUT HOW MUCH YOU CAN SAVE MONTHLY
This step is where budgeting comes in. If you don’t know how much you can save every month for your emergency fund, it’s probably because you don’t have a firm grasp on your monthly budget. Let’s change that!
If you don’t already have a budget set up, check out my guide on setting up a monthly budget.
If you already have a budget in place but don’t have extra money left over to put toward your emergency fund, go through and figure out where you can make cuts.
You may currently be making extra debt payments, and that might be a good place to cut until your emergency fund is in place. Otherwise, find some other discretionary spending such as eating out or a vacation fund you can divert budget money from.
STEP 3: MAKE IT AUTOMATIC
I used to tell myself that I would save whatever money I had left at the end of every month after my expenses. And time after time, the end of the month would roll around, and I would have spent everything. There would be nothing left to put into savings.
Finally, I changed my strategy. I set up an automatic payment to go through the day after my paycheck hit my bank account every month. Then I could only spend what I had left after savings.
It’s easy to have the best of intentions when it comes to saving. But I think we can all relate to a situation where we spend more than we plan to. Setting up an automatic transfer to savings is the best way to make sure it happens every month.
Read More: 6 Easy Ways to Automate Your Finances
STEP 4: SAVE ANY WINDFALLS
I don’t know about you, but I love those cash windfalls that come in throughout the year. Sometimes it’s a tax return (or finding out you owe less in taxes than you had saved). It could also be a little bonus or a raise at work.
Another windfall many people don’t think about is that extra paycheck some people get a couple of months per year. If you get paid every other week, then there are actually two months per year where you get three paychecks instead of two. I always look forward to those months, as my husband gets those extra paychecks.
While it might be tempting to spend those extra windfalls on something fun, there are probably better uses for them. If you’re still saving your emergency fund, then throw those windfalls in there. Once your emergency fund is fully funded, then you can throw those windfalls toward a different financial goal!
STEP 5: FIND WAYS TO EARN EXTRA MONEY
At some point, there’s only so much you can cut from your budget. Even if you’re as frugal as can be, the money can only go so far. That’s where extra money comes in.
I love having a side hustle. I started my blog years ago and worked on it alongside a full-time job. A few years later, I added freelance writing to the mix. But in the years when I was really building up my financial health, that extra income was a life saver.
The good news, it’s super easy to earn extra money every month. Some of my favorite side hustle ideas are super easy to get started and can earn you $1,000 (or more) every single month.
STEP 6: REEVALUATE AND REBUILD
Your financial needs are going to change a lot during your life. You might decide today that $5,000 is plenty for an emergency fund for you. But fast-forward a few years, and your life might look totally different.
In that case, you’ll need to reevaluate whether your current emergency fund is still sufficient. In general, the higher your monthly expenses get, the bigger your emergency fund will need to be.
The other thing to keep in mind is that something you’ll need to rebuild your emergency fund. Emergencies are bound to pop up sometimes — that’s what the fund is for!
When you find yourself needing to spend some of that money, be sure to build it back up afterward. It might be that it was a relatively small expense, and you can get the fund back up in a month or two.
In the case of a job loss where you end up draining the entire fund, it’s going to take you a lot longer to get it back to where it was.
Don’t get down on yourself if that happens — that’s what the fund is for! Your life will probably be a constant back and forth of building up the fund and then having to use it.
I think we can all agree that unexpected financial emergencies suck. But they’re also inevitable and something we should all be prepared for.
If you use the tips in this post to boost your emergency fund, you’ll have a lot more peace of mind next time one of those unexpected costs rolls around.