A properly funded emergency fund can be a lifesaver. One of our biggest focuses at The Money Checklist is removing uncertainty. With a fully-funded emergency fund, you can have months of security.
An emergency fund is a sum of money reserved only for unexpected and unavoidable significant expenses. As the name implies, these funds should only be used for emergencies!
An emergency fund removes uncertainty and stress. You can't predict what life will throw at you, but you can expect it to happen at some point. When an unexpected expense does arise, you will be able to sleep at night knowing you have planned for it and can cover it.
A second benefit of having an emergency fund is avoiding using credit cards and loans to pay for the expenses. If you have to resort to debt to pay for an emergency, there is a good chance you will end up paying interest, as well.
The ideal scenario would be to never have to use your emergency fund and have the money feel like it is wasted potential. In that situation the security that the money brings, even if untapped, is worth more than the money in the account.
We recommend having the greater of one month's expenses or $1,000 to start. This is the bare minimum when you are working towards becoming debt-free (excluding your mortgage).
Three months' expenses is a good second goal. If you were to lose a job, often you could find something new within a few months.
After you are debt-free, excluding your mortgage, The Money Checklist recommended minimum is six months. This may seem excessive, but it is better to be over-prepared than under-prepared.
The 2008 recession and COVID-19 were both "once in a lifetime" events that happened twelve years apart. Millions of people would have benefited from having six months of living expenses covered during these times.
The max we recommend is one year's worth of expenses. Anything more than that and you are missing out on opportunities for that money to grow. We don't think one year is excessive though. Unexpected circumstances can last a long time and unexpected expenses can be much higher than $1,000.
As with most personal finance topics, your situation will determine what is best for you. Here are a few examples that can change your emergency fund goal:
We recommend keeping your emergency fund in a high-yield savings or money market account with a debit card. The fund should be separate from your everyday checking account. When the funds are kept together, it becomes harder to track and gives more opportunity to accidentally or purposefully spend the money on non-emergencies.
High-yield savings account interest rates are relatively low despite the name. A half of a percent is near the top of what you will find. Your emergency fund is not an investment, so any return is just a nice bonus.
It is ok to have a small percentage of your emergency fund held as cash. Keep it in a secure place and only use it for emergencies.
When you need to use your emergency fund, you will treat it the same way you use your checking account. You can withdraw cash, or use a debit card to pay for an emergency. Then once you are past the emergency, you can start to rebuild the emergency fund to your desired level. We recommend following the steps you used to first build your emergency fund.
Building an emergency fund is a common financial goal no matter where you are on your financial journey. If you do not have one then get started now. If you had a $1,000 house or car repair bill tomorrow, would you be able to handle it? Building an emergency fund is a great first step in learning how to save and understanding your savings rate. Build your emergency fund and feel the stress relief today.
