What is an Emergency Fund & Why You Need One
An emergency fund is the most important account that everyone should have. If you are in a position to be saving toward one, it should be your number one priority, over paying off debt and investment contributions. An emergency fund is a fund that provides you the peace of mind that you will be financially covered when disaster strikes. This fund is for emergencies. An emergency is something like you losing your job, your dog getting sick, your car breaking down, unexpected medical bills, or your apartment flooding. Hopefully you have insurance for that last one but you’re likely to see some out of pocket costs while waiting on the reimbursement. The point is, an emergency fund is not for concert tickets for that concert that you can’t miss but don’t have the money for elsewhere. It is for true emergencies.
If you do not currently have an emergency fund, you should be stopping all retirement contributions and paying only the minimums on any debts. I know this can sound scary but your entire focus at this point should be building your emergency fund as quickly as possible and to do that, everything extra needs to be thrown toward that goal.
How much should you save?
How much money you should have saved in your emergency fund is up for debate but I recommend 3-6 months of living expenses. One pretty famous guy recommends only keeping $1,000 in your emergency fund while paying off debt but I think this advice is outdated and inaccurate. $1,000 doesn’t even cover a month of rent for most people, let alone anything else. The ultimate goal is to fund up to 6 months but starting out, you can stop at 3 months worth of expenses if you have other factors to consider, such as paying off debt. Other factors to consider would be your job security and whether you have dependents. Maybe you have debt to pay off but you lack job security. In this case, I would feel more comfortable building a 6 month fund before tackling that debt.
Okay, so now we know what to do but how do we do it? What constitutes living expenses and where am I supposed to put this money? When calculating your monthly living expenses, calculate all of the things you cannot live without. This should look like rent or mortgage payments, insurance payments, utility bills, groceries, gas, student loan payments, phone bill, etc. For me this also includes Netflix and enough left over for takeout once or twice a month because those are things that I cannot live without! Just because you’re experiencing an emergency doesn’t mean you have to deprive yourself of all comforts. Plan for those now so that you can still binge your favorite shows if you do experience something like job loss.
Where should you keep it?
Once you add that all up, multiply it by the number of months you plan to save and you got your goal amount. Now we need to put that money somewhere that it is working for you and that is a High Yield Savings Account. A HYSA is going to offer a yield significantly higher than that of a traditional savings account. As of today, APYs are up to nearly 5%. If you’re not sure where to look, Nerd Wallet has a good article comparing options here, which is a good starting point.
”I really don’t think I need 3-6 months of expenses in savings”
I really think you do. Okay, so you’ve got job security, excellent health insurance, no pets or dependents and a car warranty. Odds of you needing 3-6 months of expenses may feel slim but an emergency can look like so many things. But besides that, there’s another strong reason you should have an emergency fund. An emergency fund is also sometimes referred to as a ‘f*ck you’ fund. What that means is that by having an emergency fund, you have the freedom to leave toxic or unhealthy situations (such as a a toxic work environment or an unhealthy relationship) without having to worry about how you can afford it. The fact of the matter is everyone could benefit from having a nest egg tucked away (in a HYSA!!) for a rainy day.
