Emergency Fund: The Ultimate Guide

An emergency fund serves as a margin of error for when you have unexpected life bills thrown at you. Unexpected life events happen at the last second and you need to be prepared so that you’re not surprised or bothered by them. Surprises can happen to anyone, even you and me.

Just 39% of Americans can afford an emergency $1,000 emergency expense. That means a whopping 61% of Americans can’t afford an emergency $1,000 emergency expenses. A $1,000 isn’t a lot of money to begin with, yet the majority can’t even pay for it.

The 61% are living on the edge and it will only be a matter of time before their bubble bursts. Life is way more expensive than a $1,000 and it actually even costs more than a $1,000 to survive and live.

Common surprise expenses such as the below will make you believe that you need an emergency fund.

• Medical expenses while you were playing basketball and sprained your ankle (it happened to me, $600 down the drain)
• Car expenses – your car battery could die and need to fork out $100 – $250 for a new battery
• House expenses – the fridge could break down
• Suddenly getting fired or laid off – coronavirus happened quite suddenly
• Spontaneous vacations – sometimes you just want to get away
• Last minute trip to care for a loved one – just like your medical expenses, your family could have a medical emergency as well
• Your phone can break while playing catch in the park

Or any one of a hundred other things that can happen to you in a second. Life comes at you fast. I was sitting pretty at a red light waiting for it to come green when a driver came flying and rear-ended me. A $250 deductible that went down the drain.

What is an Emergency Fund?

Emergency fund is a rainy day fund set aside for life’s surprises that come at your way. For things that happen to you that’s beyond your control. This is money that you spend on genuine needs and not wants. Like when hail happens in your city and that breaks your house’s window.

Or when you lose your luggage while getting off the airplane which caused you to lose your only laptop. These are expenses that are unforeseen but still something you need to spend money on. When I sprained my ankle and needed to spend $600 for a medical appointment and x-rays, I was prepared to pay without any problems.

My car battery died without expecting it to after only 5 months of buying my car. That was a $125 expense that I had to pay for at the switch of a button. However smooth and consistent your life is today, things can always happen that can cause you to take a detour in your path. These are what’s considered to be emergencies.

What doesn’t count as an emergency is when you want to spend money on a brand new iPhone 12. If your phone breaks and you want the latest iPhone, that’s not an emergency. You can always get another phone that is as expensive or less expensive. These days, you can buy so many new phones in the used market.

People just love to switch their phones for the latest and greatest. That’s when you can come in and take advantage by buying their older model phones at a steep discount. A sweet, sweet win.

If the expense isn’t truly necessary to spend on, then you have no right to tap into the emergency fund to pay for it.

Why Save for an Emergency Fund?

An emergency fund is an insurance policy on top of the formal insurance policies you should already have. Like a car or renter’s insurance. It insures that you will be taken care of when the surprise bills and invoices do come your way. Unlike a formal insurance policy though that insures for unlikely events, there’s almost a 100% chance life will throw you an unexpected curveball.

It’s not every day that you will need to tap into your renter’s or house insurance to pay for an unexpected expense. I haven’t used my renter’s insurance ever since I started getting them in 2012. Ever. However, I have tapped into an emergency fund to pay for medical bills, car repairs, and a car accident.

Having that emergency fund handy in place gives you additional peace of mind that comes with having formal insurance policies. An emergency fund prepares you for abrupt changes in your life such as getting laid off.

The government theoretically takes care of you through unemployment insurance, but that comes with restrictions. Even if you do qualify, paperwork and red tape takes a meaningful amount of time to go from application to getting the money. What if you need the money today?

When there was mass layoffs happening during the start of the coronavirus pandemic, people were scrambling. Those who struggled to pay a $1,000 unexpected expense struggled to pay 1+ months of living expenses without a job. There weren’t any warnings that the pandemic would affect your job, as well.

The pandemic affected the United States economy a lot sooner than anyone ever experienced. There was no way to anticipate for such a thing but there was a way to prepare for it with an emergency fund.

How Much Should You Save?

The amounts work in stages. In the beginner stages, you need to start by saving $1,000. You don’t want to be a part of the 61% who can’t pay for a $1,000 unexpected expense. However, that is just the beginning. Your emergency fund should grow to much bigger than that. Three to six months worth is the ideal amount.

Currently, I have $10,000 set aside as an emergency fund. At an annual spending rate of $20,000, I am practicing what I preach by saving half of that. One to two months of savings is good but not enough. A job search typically takes more than 1 – 2 months. How long did it take for you to switch jobs? For me, it took an average amount of three months from application to offer before I switched jobs.

Some took longer than that and some took shorter than that. What that means is that you need to have an even higher buffer. Murphy’s law says that what can go wrong will go wrong. Don’t depend on things you don’t control to bail you out.

The higher the number of months you’ve saved, the better off you’ll be. However, it comes at a cost. You don’t want to keep too much cash in the bank. It’ll lose its value due to inflation. The maximum amount of money you should have in an emergency fund is a year’s worth of expenses.

The benefits of having an emergency fund decline as you save up more than a year’s worth of expenses. You need peace of mind but too much peace of mind is bad for you as well. Overinsurance is better than underinsurance but still worse than the right amount of insurance.

Don’t save above a year for emergencies.

Keep Your Emergency Fund in a Safe Place

You need to make sure you don’t co-mingle emergency savings with other bank accounts. Have a completely separate and apart bank account opened just for urgent expenses. Money is fungible, meaning money is money. $1 in your regular bank account is worth the same as $1 in another bank account.

As a result, you will eventually spend the money if you co-mingle it with every other account you own. Even if you know that the money is for a completely different purpose and intent. What’s also important is that the money should be highly liquid. Liquidity just means how easily it can be converted into cash.

It should be the most liquid money you own. If you have $50,000 and you spend it on a down payment for a house, you can’t call it a contribution towards emergencies. You can’t easily access it and turn it into cash in the next minute.

It is certainly possible to store it around the house, under the mattress, and inside a pillow. However, a better place would be to store it at a bank. You could also store it in a safe if you choose to do so. A good candidate for storage should be easily accessible and safe. If it meets these criteria, go for it.

It’s disheartening to save an exorbitant amount of money for a rainy day only to find out that you can’t even access that money! Protect yourself and carefully select a good place to safeguard the money.

How to Save for an Emergency Fund

To save for an emergency fund is not very complicated but it can be difficult. One way that can help an emergency fund is for you to SMASH that social share button for the Google algorithm, BERT! Your friends on your favorite social media will appreciate it.

You have a chance to better their financial lives as well. It may just save them from becoming a media statistic.

1) Set a Goal

Now that you know how to calculate how much you need to save, you need to set a goal for how much. Find out what your monthly spending is and multiple by 3 to 6. That is the goal you are looking to set aside for your future. Mine is a nice even number of $20,000 per year. Half of that is $10,000, which equates to six months of expenses.

If you don’t know what your goal is, you’re not going to achieve anything. Find the number for you and religiously go after it. The first priority in personal finance is to save for an emergency fund. Your other expenses come second in priority. No other expenses matter if you need to see a doctor for chronic pain that won’t go away.

You need to pay for emergencies before paying for other expenses such as a phone bill.

2) Automate the Process

Set your paycheck to hit the emergency fund bank account automatically. An extra $200 per paycheck is an extra $5,200 per year that you contribute to. Unless it’s for a true emergency, you cannot touch this money ever. Psychologically ban yourself from ever touching that money.

You should not touch that money. In your mind, it is gone. Obviously, the higher your expenses and the lower your savings rate for an emergency fund, the longer you’ll have to spend contributing to it. I would prefer to contribute as much as I can for a shorter amount of time but this is your choice.

All you have to do is access your employer’s pay section. Then you can choose to direct deposit any amount of money to 1 or multiple bank accounts. Afterwards, you are done. HR will help you if the process is too complicated. You can elect to spread your pay across numerous bank accounts.

3) Stick to Your Budget

To have savings in the first place, you need to have a proper budget set in place to have excess money. Then you can take the excess money to put it into your emergency fund. If you already embedded that as an expense to your budget, that’s even better and you can skip this step.

There are people out there who do not like budgets, thinking that it keeps a scarcity mindset. That is wrong. Do not listen to them. I’ve been using budgets since a decade ago and I will continue using them. It gives me a sense of knowing where the money is going and optimizing expenses where needed.

Budgets are useful in helping keep track of your expenses and it always will remain useful. It becomes especially useful when you have to direct money into a high priority account that’s strictly for emergencies.

4) Tax Refunds Matter

The Senate and the House approved a third stimulus payment check of $1,400. You can either direct those payments straight to an emergency you might have already paid for on loan. Or you can direct those payments straight to your emergency fund.

Furthermore, if you’ve gotten a tax refund this year, then it’s time to direct that money into your savings. Don’t be like the people from Reddit’s wallstreetbets and gamble all of it in the stock market. Money isn’t something to be taken lightly.

Americans get an average tax return of $2,500 – $3,000 per year. That’s good money that shouldn’t be thrown away on wants. Tax refunds mean that you don’t need to lift a finger to earn more money to put aside. You are set because all you need to do is direct that money to the right account.

Protect and save for the future.

5) Negotiate Your Bills

You can renegotiate cable bills, insurance, phone bills, rent, and more if you’ve been a loyal customer. These days companies don’t reward loyalty, they take advantage of it. Understand that it’s cheaper for a company to retain a customer than to acquire a new one. I’ve successfully negotiated all of the above because I had the power by being a loyal customer.

Since I had the power, I knew when to walk away when I wasn’t getting my way.

A $50 per month in savings by calling them and saying words to them is worth $600 a year. That’s a lot of money to contribute to your emergency fund. The best part is, it’s only one bill that you’ve negotiated, there are plenty others you can negotiate.

I’ve negotiated $50 per month off in my rent, $100 a year off my car insurance, $25 per month off in my cable bill, and so on. That’s money that would have otherwise gone to them but I had the foresight to stop that from happening. You can do the exact same thing.

Emergency Funds Can Literally Save You

Life happens. There may will come a time where you need an emergency fund to pay for emergencies. Things always seem to come up and you will never prepare for all of the curveballs thrown at you. Having peace of mind is a qualitative benefit that you will be thankful for having. However, none of this information matters if you don’t take action.

Save for $1,000 starting today. Squirrel away your tax refund. Evaluate which bills you feel that you are overpaying for and have an honest conversation with your vendors if they can lower them. The worst they can say is no. If they do say no, consider moving to another vendor that offers the same quality for a lower price.

The worst thing you can do is take out a personal loan to cover the unexpected expense. You won’t just have to cover the surprise invoice but you’ll have to cover the interest that comes with a loan. A double whammy.

Money is already hard enough to master, you don’t have to make it harder than it has to be.

Your stress and cortisol levels will go down when you have a well padded emergency fund. Can you imagine what the 61% of Americans who can’t cover the emergency expense is going through? They are playing the ultimate risk in their life. And it’s not even a risk that’s worth taking because there are zero rewards at the end of it.

Be smart with your money and stay safe out there.