Having an Emergency Fund is Essential
Having an emergency fund is vital to the security and long-term success of anyone’s financial future. It’s really important to leave some amount of money completely separate just in case everything turns for the worst. You just never know what might happen and having cash on hand for an emergency is always a good idea.
We’ve had an emergency fund for over 10 years now after reading Dave Ramsey’s Total Money Makeover. We’ve never had to touch it. I’m often tempted to invest some or all of that money, but I just know that the second I do that, something will happen.
Why Do I Need an Emergency Fund?
I think an emergency fund, held in liquid cash, is essential. You never really know what might happen in life. For instance, I bet a lot of people wished they had a COVID emergency fund when the pandemic hit and everything shut down. Nobody has ever been sorry that they had extra cash on hand when something bad happened.
Having a cash reserve gives you space and time to make more optimal choices. Pressure tends to have a negative affect on our choices with money – or at least that’s been my experience. I think that creating time and space to come back to a problem after you’ve had a chance to clear your head and do analysis and research is really helpful. I think we have made much better decisions just by giving ourselves wiggle room to think and not just react.
A safety net gives you the little bit of extra confidence needed to take some healthy financial risks. This might be quitting a job that’s not a right fit or going back to school. These will likely stretch your budget thin. Without that safety net, running on thin margins might be a really big source of stress. Running low on cash can become a real issue if something bad happened. You never know when a major car repair or deductible on a hospital visit might occur.
Do Not Invest Your Emergency Fund!
Investing your emergency fund is NOT a good idea. You could lose that money or tie it up so you can’t use it if a need arises. Think about it. If you’re stuck in a hole, do you really want to keep digging deeper?
What would you use as a safety net instead? I’ve heard of people using a credit card, Home Equity Line of Credit (HELOC) or even borrowing against their retirement accounts as a possible emergency fund. These all have costs associated with them and I feel they only further compound the emergency. I don’t care how low the interest rate is. It just adds to the complexity and size of the problem at hand.
Obviously, you can do what you want to, but having an emergency fund helps keep you on track and takes a lot of stress out of the equation when something bad happens. I did a YouTube video on this, but sometimes an emergency fund might be the only thing that stands between an emergency and you making a bad decision.
Emergencies Will Happen
Imagine this, you’re working to get your finances on track, paying down debt, and your car breaks down. If you have an emergency fund, you pay for it with your cash and then build it back up and move on. If you didn’t have the emergency fund, you would now likely have to borrow that money. This would further compound your problems. You can get stuck in a vicious cycle of just trying to keep your head above water.
I know for us, having the cash on hand for these things has greatly reduced our stress. What’s interesting is that we have never used the emergency fund. However, we also avoid touching it like the plague. We are generally able to get creative and adjust our expenses if something difficult arises. We might end up running on thin margins or pulling from other savings, but having that buffer really puts us at ease.
Where to Keep Your Emergency Fund
We keep the emergency fund in a totally separate bank from our normal checking and savings. This way we aren’t tempted to use it for random things. We do have a checking account at that bank, so I can transfer and use the money almost instantly if needed. It might not be necessary to keep it in a totally separate account. I also labeled, or nicknamed, the account as the emergency fund. This creates physical and mental separation from everything else. It just keeps it simple for me that way.
How Much Emergency Fund Should I Have?
That’s a great question! Generally 3-6 months is considered a good baseline. For us, we started with a $1,000 baby fund. Then we ramped that up to roughly 6 months of expenses. At the time, that was about $5,000. For you, I think you need to factor in how much you really need to live off of each month and how likely a job layoff is. This is likely really hard to predict, but think about it. Has anyone at your company been laid off or furloughed in the last year? Has any company in your sector gone out of business in the last 10-15 years? Not everyone that has found themselves without a job saw it coming.
Remember to Revisit Your Emergency Fund
Our expenses and income have grown over the years. We currently live in a pretty high cost of living area. That same $5,000 emergency fund is only about 1.5 months of living expenses currently. My day job is very stable, so I haven’t worried about it too much. However, my goal this year is to double our current emergency fund so we have about 3 months of expenses saved up again.
I hope this gives you something to think about and helps clarify some of my previous discussions on emergency funds.
Action Items
- Set up your emergency fund now and nickname the account.
- Make a plan on how to build up your emergency fund and how much you need to save.
To contact me, please email me at hello@start100k.com
Now go get started!
Please remember this information is for educational and informational purposes only. Please seek tax, legal, or investment advice before making any decisions.