How to start an emergency fund

One of the most common mantras you will hear in the personal finance world is to create and fund a comfortable emergency fund. An emergency fund is money set aside to get you through some sort of life’s unexpected emergencies. I hear a ton of questions and uncertainties from people about why they need an emergency fund and how to use it, so here are the answers to those questions and information on how to start an emergency fund. 

What is an emergency fund?

An emergency fund, rainy day fund, safety net, sleep at night fund are all names that people give these accounts. It is a safe account of money, often three to six months of income or expenses, that is designed to get you through life’s true emergencies. 

These emergencies can run the gamut, but it would be situations like an unexpected job loss, repairing your house if a tree falls on it, covering a replacement car if yours is suddenly totaled and insurance is not covering the vehicle, covering the deductible for a catastrophic medical event. 

An emergency fund is not money stuffed under your mattress. It is good to have some emergency cash at home (a few hundred dollars would be my recommendation), but you do want to earn as much interest or growth on this account as you can without volatility. You don’t want to have a car accident today and realize your emergency fund is now worth ½ what it was worth yesterday, just because the stock market went down. A saving account is where this fund needs to live. 

What isn’t an emergency fund?

First, an emergency fund is not F-money. An emergency fund is designed to cover several months of expenses, while F-money is to address a one-time situation.  

Your credit card does not constitute an emergency fund either. If you are unable to pay for the emergency in the billing cycle, you will then get the privilege of paying 20%-30% more for that emergency in interest on the credit card. If you are struggling to make ends meet in an emergency, you really don’t want to be paying any extra interest on that emergency. 

An emergency fund is not for the vacation to Italy you have always been dreaming about, or to remodel your house (unless a tree fell on it), or the latest and greatest tech item. The fund is not to be used to get huge growth or stock market gains. It needs to be stored in a safe and non-volatile investment vehicle (usually a high yield savings account).

An emergency fund is not just for “rich people”. In fact, it is more important for lower-income or average-income folks who may not be able to handle a sudden job loss or emergency with their income source. 

How do I start an emergency fund? 

1. Pick a savings account or bank to have the account at. You want to look for an account that pays higher than normal interest (often called a High- Yield Savings Account). You want the money accessible in the event of an emergency, but not accessible enough that you can spend it at the store on a whim. I use Capital One 360, and it takes 3 business days to transfer the funds into my checking account. I can use my credit card to bridge that gap if something needs to be paid for immediately.
2. Start small. Set up an automatic transfer on the day you get paid each month or 2 weeks to go into this fund. Set a goal to get to $1,000 in the account as quickly as you reasonably can. 
3. Don’t touch it! The key to this account is there will be funds available waiting for you in an emergency. This means you can’t raid it every time you see a new pair of shoes you want or a tech item you want. 
4. Calculate how much you need in your emergency fund and keep saving. I walk through the calculation in the next section. The good news is, once you hit that number, you can stop contributing until you need to use the money or need to increase the balance of the account because your lifestyle changed for some reason. 
5. Sleep better at night knowing that you have the financial resources to weather emergencies that come your way!

How much do I need to save in my emergency fund? 

The answer is “it depends”. Don’t you hate being told that!

Common personal finance experts have varying recommendations, but many of them fall in the area of three to six months of living expenses. To figure out what level you are comfortable with, consider the following steps: 

1. Calculate how much you spend monthly. I recommend calculating a normal month, including some luxuries like eating out or fun activities. If you are in an emergency situation, you can always cut your spending to the bare minimum (no eating out, only free activities, cut cable/subscriptions, etc), but having an accurate number gives you a little extra “fluff” to handle what life throws at you. 
2. Consider the “worst-case scenario”. What would it cost for your family to weather a true crisis? Think about the horror stories from some of your friends and family. If you were in Aunt Mary’s unexpected layoff from her job of 35 years, how much would you need to get your family back to normal? How about the time that your college friend woke up to find a giant tree on the roof of the house she had owned for 3 months? What would it take to get that tree removed and the house repaired?
3. Set a savings goal. After considering those few points, what amount makes sense to you? Make that a goal and adjust your automatic deposits into the account. Now sit back and watch the account slowly grow. 

When can I use my emergency fund? 

The short answer is when you are in an emergency situation and you do not have other sources of money to handle this emergency.

The longer answer is a variation of “it depends”. I gave some examples above, but often emergencies don’t announce themselves as emergencies. I think it usually falls into different variations of the following categories:

• Loss of income/job
• Medical care
• Necessary basic transportation
• Keeping a roof over your head 
• Ensuring you have the basic necessities like water, food, and heat.

NOTE: I am going to contradict myself a bit, but stick with me. I said earlier that a credit card is not an emergency fund. However, a credit card can be part of an emergency fund. What do I mean by that? If you were in a car accident and your car is totaled. You need a vehicle until your insurance company can figure out the details and get you the funding for a replacement car. Use that credit card in the interim to rent a vehicle to get you around, and then initiate a transfer from your emergency fund to have the cash available in 3-5 days to then pay for it. A credit card can be a great buffer for short-term spending while you figure out the funds to pay for the item. 

Just make sure you make full payment before the statement due date so you don’t pay interest and penalties!

Life is tough. It throws all kinds of curveballs your way and an emergency fund can help soften the blow when that curveball hits you. When faced with a true emergency, people are often faced with needing to make many important decisions in a very short period of time. Having this emergency fund in place takes away needing to decide how to pay for the emergency or worrying about how you will pay for rent and a medical deductible. You can focus on your and your family’s health and safety as the top priority. That in itself is the best gift you can give to yourself. By taking the time now to figure out how to start an emergency fund, future you will appreciate it when they are in the middle of dealing with an emergency or crisis of some sort. 

I would love to hear from you. How have you seen an emergency fund help a person through an emergency? Share below in the comments or on our Instagram page.