Is an Emergency Fund Really Necessary?

An Emergency Fund is money that you’ve set aside for unexpected expenses, including things like medical costs, home and car repairs, or covering your living expenses if you lose your job. Ideally, the money is in a dedicated savings account, separate from any other savings.

Unexpected expenses are inevitable. We may not know when, or how much they will cost, but it is naive to not anticipate that they are coming. Without an Emergency Fund, you may have to take on expensive debt to cover these types of costs. Or you might be forced to make a less-than-ideal decision, like forgoing medical treatment. Having an Emergency Fund is essentially an insurance policy you’ve created for yourself for the unpredictable events in life. 

Why is it important?

Managing a crisis is stressful in so many ways. Knowing that you have money set aside for these moments, makes it a lot easier to navigate them. 

If you’ve just lost your job, having enough saved to cover a few months of living expenses allows you to take some time to find a new job that is actually a good fit for you, rather than desperately taking the first job you can find. 

If you are dealing with a medical emergency, having an Emergency Fund allows you to focus on the best course of action for your health, rather than stressing about how you will pay for the ambulance ride or ER visit. 

Without a financial buffer, you may be faced with less optimal options. When you find out that a relative, who lives across the country, is dying, but you don’t have the funds to buy a last-minute ticket to see them, do you miss out on seeing them one last time, or do you put the ticket on your high-interest credit card? 

Unexpected emergency expenses can kick off a long cycle of debt. But if you’ve saved up the money ahead of time, you are in a better position to handle these situations. While you may not know what type of emergency is coming, you can assume that SOME sort of emergency will arise eventually. Making a plan to be prepared now will prevent you from getting stuck in a situation where you have no good options to choose from.

How much do I need?

3-6 months’ worth of your living expenses is the typical recommendation. 

A job loss is the most expensive financial emergency that most people are likely to face. That is the hypothetical emergency most people are thinking of when determining what their goal Emergency Fund amount should be. Having enough saved up to cover your cost of living for a few months should reduce the sense of panic if it takes you a few months to find a new job. 

When calculating their monthly living expenses some may opt to only calculate their most essential expenses. This is based on the assumption that you’d cut all of your non-essential spending if you were suddenly unemployed. 
Alternatively, you may want to factor in at least some “non-essential” expenses into your core living expenses. Unemployment can be an emotionally challenging time, so knowing you can afford to keep some costs that boost your mental or physical health (think therapy, social outings with friends, gym membership) might help you through that phase a little more smoothly. 

Determining if you should be aiming for 3 months, or closer to 6 months’ worth of living expenses will depend on a number of factors. The primary considerations are how long it will take you to get a new job and how flexible you are with reducing your cost of living. 

If your skill set is highly sought after, and you could find a job in multiple industries, it's likely you could find a job relatively fast, so a smaller Emergency Fund may be fine. But if there are fewer places hiring for your specific skills, or you work in an industry that is more volatile, you may want to be financially prepared for a longer job search. 

If you are single, have a month-to-month rental agreement, and could move back in with mom and dad in a pinch, you have more flexibility in your expenses than someone with 2 kids in daycare and a mortgage. If needing to scale back your expenses would seriously impact you or your family’s quality of life, consider aiming for a higher savings amount.

 Some questions to consider when determining how big of an emergency fund you should aim for:

• How stable is your job? 

• How easy would it be to find another job? 

• How recession-proof is your job?

• Do you have a partner who could help cover expenses? 

• Is your partner in the same industry? Could you be laid off at the same time?

• Do you have family or friends that you could move in with, or who might help you out in an emergency situation? 

• How flexible are your costs? 

• Do you have kids? You may be able to cut your own costs drastically in a pinch, but if you are supporting a family, the costs are often much less flexible. 

• Are you self-employed?

Depending on your situation, and your risk tolerance, you may even consider a 6-12 month emergency fund. For those who are self-employed or have significantly variable income, a 12-month emergency fund could make sense. Having a larger emergency fund can reduce the level of stress that comes with temporary dips in income. 

OK, that's unrealistic

If you don’t currently have an Emergency Fund, saving 3-6 months’ worth of expenses (or maybe even 12 months?!?) may seem laughably unrealistic. If saving ANY money is a real challenge, saving 10s of thousands of dollars may feel beyond feasible. In that case, start small. No one is expecting you to have $20,000 saved by next month. But if you start slowly building it up, perhaps you will get there within a few years.

If you are new to having an Emergency Fund, focus on a smaller target amount, like $1,000. Sure, $1,000 may not be enough to cover a larger emergency, like a job loss. But $1,000 might cover a smaller emergency. And if you do have a bigger emergency expense, having $1,000 is a heck of a lot better than not having anything saved. 

Once you get to $1,000 in your Emergency Fund, you can slowly stretch your goal amount. 

Where should I put it?

Keep your Emergency Fund in a separate account. If you have one savings account for your emergency fund, money for an upcoming trip, and the beginning of a down payment fund, it's hard to mentally separate what the money is for. 

When we see one overall balance, our brain blurs what the purpose of the money is. We see $20,000 in an account and think “I have $20,000, my emergency fund is set!” then a week later when pursuing Zillow we calculate what we could afford using this same $20k as the potential down payment Then when it’s time to book your vacation, you don’t bat an eye at the price because hey, you’ve got $20,000 saved up! 

Our brains are not great at mental accounting. It’s too easy to double (or triple) count your money. It’s too easy to spend your Emergency Fund on non-emergency expenses.  But if we separate out the money into different accounts, we can clearly see what we have dedicated for each use. 

A High-Yield Savings Account is a great option for an Emergency Fund. You won’t get rich from the interest earned, but you will earn more than you would in a traditional savings account. Take advantage of that free money! 

Keeping your Emergency Fund at a different bank than your primary check account makes it a little harder for you to dip into it for non-emergency, impulse purchases. There are lots of great online banks offering High Yield Savings Accounts (just make sure it is FDIC insured). 

Automate

Saving for an Emergency Fund is the responsible thing to do. Unfortunately, it’s not that exciting or motivating to do the boring, responsible thing. If you have to actively decide to save each month, most of us will struggle to do it consistently. The best way to overcome that is to automate it. Make it happen without you having to think about it. 

Figure out how much you can reasonably, and consistently, afford to save each month, and set up an automatic transfer from your primary checking account to your Emergency Fund account. 

Using your Emergency Fund

When an emergency expense arises, sometimes people feel bad actually using the money they saved up. It took a long time to save it up, so it may sting a little to see it go. A helpful reframe is to celebrate the fact that you did the hard work of saving it, and now you were able to handle the situation knowing exactly how you would pay for it. Gold stars for you!

As you are building your Emergency Fund, take some time to think about what really constitutes an emergency, and what some of the more likely emergency scenarios might be for you. Envisioning potential uses for this money may make you feel a little less guilty when you need to spend it. It can also help clarify what is a valid use of this money, and what isn’t. 

When you do spend some, or all, of your Emergency Fund, you’ll want to start thinking about how and when you will replenish it. We never know when the next Emergency Expense could pop up.  It’s probably not feasible to replenish it immediately, but create a plan to slowly start building back up to your goal amount. 

Having a dedicated Emergency Fund is a great way to protect yourself, but if you are struggling to hold on to any savings, you may benefit from some additional support. Schedule a call with Sarah to develop a strategy that will help you effectively save for your future self.