Let’s Talk Emergency Funds

What was the last purchase you made that had you dipping into your emergency fund?

What was that, you say?  You don’t have one?

First off, let me tell you that you’re not alone.  Savings rates in the US are terrible.   Even those who have the money to save do not necessarily save or have an emergency fund. You could be making $50k a year or $500k a year- it doesn’t matter. There are too many financial obligations at every income level, and having an emergency fund just sitting there for emergencies can seem wasteful when we’d rather be doing other things with our money.

OK, if you don’t have an emergency fund, think back to that last major purchase you made that was considered an emergency.  How did you pay for it?  Did you borrow money from friends or family?  Did you go into credit card debt? Borrow money from yourself using either a home equity line of credit or through a retirement account?

Notice what all of those methods have in common.  They all require borrowing.  Which means you have to pay it back at some point.  Which then leads to the whole point of having an emergency fund.  

You have an emergency fund so that you can easily pay for these inevitable emergencies and have peace of mind.  You will not owe anyone a penny because you borrowed money from them, avoiding a potentially awkward situation.  You will not need to borrow from yourself and risk your home or your retirement account. You will not need to ask other people for money via a GoFundMe page. 

Yes, you will need to build back your emergency fund, but you can do this on your own time without owing additional interest.  Things WILL break down or need to be replaced unexpectedly.  Medical issues will arise. Sometimes you need to make travel arrangements last minute because of a family emergency.  You might even lose your job.  Life happens, and it’s nice to know that we can prepare for some of these events financially.

HOW MUCH?

So how much do you save?  For most people, 3-6 months of living expenses is the norm.  If you still need to figure out your living expenses, start your own spending plan to get a detailed look at how you spend your money.  Typically, if you’re in a 2 income household and in a stable job, you can get by with 3 months of living expenses.  If your household requires just 1 income and/or the job situation is not very stable, then plan for something closer to 6 months of living expenses.  

Dave Ramsey’s popular Baby Steps recommend that you start with $1,000 as a cushion.  Shoot for this goal as a bare minimum.  This will give you time to figure out what you’re actually spending. Then work up to your calculated emergency fund number as quickly as you can while meeting your other financial goals.  You want to fund this sooner rather than later.  Why? Because one major financial setback has a ripple effect on the rest of your finances, making it much harder to play catch up.

Also keep this in mind: we are due for another bear market.  We are in the midst of one of the longest running bull markets in history, and when looking back at stock market history, bear markets are inevitable.  When and how long it will last is anybody’s guess. But you will be very thankful that you have an emergency fund once the economy takes as downturn, especially if you feel like your household income is dependent on a strong economy.

HOW DO YOU BUILD UP YOUR EMERGENCY FUND?

The easiest way is to pay yourself first, meaning that whenever you get your paycheck, immediately put a percentage of it into your emergency fund.  Any time you receive a bonus or extra money, sock some of that away in an emergency fund.  If you have gone through your spending plan and found out that you could cut some expenses, go ahead and put that in your emergency fund.  You will need to decide how aggressively you want to contribute to your emergency fund, as you will have other financial obligations you need to meet at the same time (i.e. retirement, other savings goals, paying off debt).

WHERE DO YOU KEEP YOUR EMERGENCY FUND?

When you need to pay for an emergency, you want the money in a hurry.  This means that you should keep it in a liquid account, where the money is easily accessible.

1. Regular savings account: You likely already have one of these at your local bank.  You can usually open multiple accounts at the same institution in order to earmark them for separate savings goals.

Pros: Very easy to set up. Easy access. Ability to visit the bank in person for customer service.

Cons: A big negative is that bank savings accounts have dismal interest rates at the moment.  For example, many major banks offer less than 0.1%.  Check with your local bank to see what it offers.

2. Money market account (MMA): These accounts are actually invested in low risk securities, such as CD’s or government bonds.  It is still FDIC insured, so you have the government’s backing with your money.  

Pros: You will get higher interest rates with a money market account.  You can find money market accounts at banks and credit unions.  

Cons: They usually require a higher balance than a regular savings account.  

ONLINE BANKING

Brick and mortar banks have a lot of costs they need to cover.  Things like actual buildings and all of the associated costs that go along with working out of a building.  Online banks don’t have this kind of overhead, and as a result, they’re able to offer higher interest rates.  Many of them currently offer between 1-2%. This is a vast difference from the 0.1% or less that I mentioned earlier.  A quick Google search for online banks can give you some options.

Pros: Much higher interest rates. Can link easily with your regular bank accounts.

Cons: Deposits take longer to post to your account and the money is not as readily accessible as it would be at your local bank.  

REASONS NOT TO HAVE AN EMERGENCY FUND?

What if you just really dislike the idea of having your cash sitting there, basically losing money because of low interest rates? That’s what happened to this particular blogger.  Here are some of his reasons for eliminating his emergency fund:

1. He and his wife are both working physicians, with the ability to work more if necessary
2. He is covered adequately by disability insurance
3. Their passive income covers more than half of their expenses

He made a personal choice based on his financial situation and his confidence in covering any financial emergencies.  This is just another example of personal finance being personal.

For most of us, I think an emergency fund is still a really good idea.

BOTTOM LINE

• You need an emergency fund.  Life is full of unexpected events, so you need to make sure you’re financially prepared.
• You need to figure out how much to put into it.  Just shoot for $1,000 to start with.  In the meantime, get knowledgable about your own spending and save 3-6 months worth of expenses.
• You will need to figure out where to save it.  Go use your local bank for the most accessibility.  If you’re wanting better interest rates, look at a money market account and/or online banking institutions.

 

Have you fully funded your emergency fund? Do you keep it at your local bank or an online bank? Have you decided to get rid of your emergency fund? Comment below!