I’ll never forget the day my Jeep Wrangler broke down on the side of a 6 lane highway on my way to work. I had enough momentum to get myself over to the shoulder. Luckily we had AAA, so the tow was covered. But the fix on the Jeep was going to be around $2000. I needed the vehicle to get to work, to pay for the fix. We had the money, but it was going to drain our account down further than we felt comfortable and we considered putting the expense on a credit card. This… was an emergency.
Life is a crazy ride and you never quite know what the future will hold. That’s why it’s important to create an emergency fund so that you’re prepared for unknown future events that won’t derail your path to financial independence.
The best way to create an emergency fund is to open a high interest savings account that is dedicated to that purpose only. That way, you have some money kept aside for whenever you need it in an emergency.
Many things can happen that may result in you needing money in an instant. For example, your car may break down, you encounter an unexpected medical event or your home’s water heater may stop working in the middle of winter. These are all things that will need to be sorted out quickly and you’ll need money to do so. Keeping an emergency fund will ensure that you’re always ready for anything that might happen.
What is an Emergency Fund?
An emergency fund is a sum of money that you set aside specifically to help you deal with all of the unexpected things that life throws at you. It’s not money that should be spent on things like holidays or a new car – instead, it should be kept separate from your regular spending money and only used in very rare cases of emergency.
Having money set aside for unexpected fees that may pop up will help to relieve a lot of stress if the situation arises where you need some money for an emergency fast.
How Much Should You Save in an Emergency Fund?
There is really no right or wrong answer to this question as it depends entirely on your circumstances. The amount you keep aside will depend on a few things such as how much you earn, how much you spend monthly, and how much you expect common emergencies to cost.
Things You Should Consider When Deciding the Amount
Your best course of action is to begin by analyzing your current earnings and spending so that you can figure out how much you can reasonably put away each month towards your emergency fund. This will allow you to calculate how long it will take to get to your goal savings amount. To quickly analyze your monthly profit and loss, we love using Personal Capital. Their free app makes it easy to keep track of your spending, investments and even analyzes what kind of fees you’re paying on your investments. (See why fees can be the Silent Assassin in your wealth building goals!)
Next, you should consider financial conundrums that may arise due to your lifestyle, circumstances, etc. and figure out how much you would have to spend in that particular situation. This will help you come up with your goal savings amount so that you know what you’re aiming for.
Once you’ve calculated your average monthly expenses, and taking into consideration any known variables that may arise (medical conditions, old vehicles or home appliances within a few years of major repair, etc.) you’ll have a better understanding of how much you’ll need to save in total, you can start putting money away each month towards your goal.
For our Emergency Fund, we like to keep roughly 6 months worth of monthly expenses in a high interest savings account. This allows us the peace of mind that if something were to happen to our jobs, we would have half a year to create new income streams. It’s also enough to cover the most common unexpected expenses that might otherwise derail your savings and investing goals.
This account should be readily accessible, so make sure there are high daily withdrawal amounts. This way, you can access the money quickly in case of an emergency.
Now it’s time to start saving. Even if you only put a small amount of money away to begin with, it’s still a step in the right direction so that you’re prepared for anything that might happen and cost you money. For some, the emergency fund is the first savings goal to tackle. In our experience, fully funding our emergency fund was the first time we truly felt financial freedom wash over us.
Of course, if you have high interest debt, that is the first emergency we recommend you tackle. Also, if you are paying high fees on your current investments, you’ll want to read our post about investment fees and what they can do to your FI plan. Wherever you are on your path to Financial Independence, having a savings plan will help with all of these issues and get you on your way to a happier, healthier life.
Below is an overview of how you can determine how much to save in your emergency fund:
- Consider your monthly earnings
- Consider your average monthly expenses and how much you think you can put away each month
- Consider some likely events that may cost you (car repairs, home repairs, medical events, etc.)
- Determine how many months of expenses saved will cover you financially and emotionally.
How to Create and Keep an Emergency Fund
Starting an emergency fund couldn’t be easier. Simply follow the steps below and you’ll already be on your way:
Choose a Bank
The first thing you will need to do is choose an appropriate bank. A savings account is always a good idea as you can earn a little bit of interest on your savings over time. However, some people prefer to just open a regular account with the bank. The choice is up to you. As long as you have something to separate your emergency fund from the rest of your money, then that’s good enough. We use Ally Bank for our emergency fund. While it’s hard to find high interest savings accounts these days, we’ve found them to be highly competitive and easy to use. We’ve worked with them on our Playing with FIRE movie tour, and the team at Ally stands out as some of our favorite partners through that experience. That matters.
There are other ways to access an emergency fund, like taking out a HELOC on your home or locking up a portion of your emergency fund in high interest stablecoin, but we choose to keep 6 months worth of expenses in cash in an Ally Bank Savings Account because we feel more comfortable having access to cash at any given time.
Don’t Give in to Temptation
When you have a large sum of money stashed away, it can be very tempting to just dip into it every now and again. You should resist this urge and use your emergency fund for emergencies only. Otherwise it kind of defeats the purpose.
Save More Money
Whenever you get a bit of extra money or if you pay off any debts and find yourself with more money, start adding a little bit more to your emergency fund. The sooner you can reach your savings gold the better as you’ll feel so much relief in knowing that you have that money sat there just in case you ever need it. Of course, once you’ve reached your goal, you’ll want to keep that savings habit going and start putting that money toward investments!
When Can You Use Your Emergency Fund?
It can be tricky to determine when you should or shouldn’t use your emergency fund. How do you know what’s considered an emergency and what’s not?
The answer to this question is sometimes very obvious and other times it’s not that easy. For example, if you’re thinking of going on holiday and don’t quite have enough for it, this Is no excuse to go dipping into your emergency fund. However, if your car breaks down and you can’t get anywhere, this is classed as an emergency. You need your car to get around so you should use your emergency fund to fix it.
The tricky part comes when you need to decide on the things in-between. Smaller problems such as your computer breaking or if you get an unexpected bill. These types of problems will ultimately depend on what you think is right. For us, we like to put these decisions through a FIRE lens. Do we absolutely need to fix this? If so, are there any alternatives to fixing this problem besides an outright purchase or replacement? Basically, we will try to find any excuse not to spend money on an issue. If it can’t be worked out creatively, then we may go to our emergency fund to get it taken care of.
The Dos and Don’ts of an Emergency Fund
Now that you know all about what an emergency fund is and why it’s important, let’s take a quick look at the dos and don’ts of an emergency fund:
- Calculate your earnings and average monthly expenses
- Stay consistent with your savings
- Keep the pace of your savings with new expenses
- Analyze your circumstances and set realistic goals
- Open a high interest savings account
- Keep your emergency fund separate from your other money and know when an “emergency” is qualified
- Fund an emergency fund before paying down high interest debt
- Dip into your savings
- Save too much (you’ll want excess to go toward investments!)
After you’ve paid down high interest debt, and analyzed and minimized the fees you’re paying on your investments, it’s time to save for an emergency fund. Hopefully, you won’t need to worry about using it very often. However, it will give you great peace of mind knowing that you have some money set aside just in case the worst happens and you do end up needing it. It may also come in handy one day if you have an investment opportunity arise and feel confident in your ability to replenish your fund in a timely manner.
If you keep realistic goals in mind and avoid dipping into your savings, it’s very easy to create and keep an emergency fund and critical to a well-rounded financial position.