Originally Published: April 1st, 2023
Updated: September 30th, 2023
This article is all about why you need an emergency fund.
One financial tool that is not discussed nearly enough is an emergency fund. In terms of wealth building, an emergency fund isn’t the flashiest of means of building wealth, but it can be the difference between on-time debt payments and missing them, thus hurting your credit score.
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Disclaimer: I am not a financial expert (financial expert, financial planner, etc.), nor do I claim to be. I am interested in personal finance and love sharing what I learn with other people. Please be cautious of ALL financial advice that you find on the internet. Thank you.
Don’t get me started on the statistic that ~57% of Americans could not come up with $1000 dollars to pay for an emergency expense. You can read more about this here.
Some people would prioritize debt over saving for an emergency fund, but having a monetary cushion before you begin attacking your debt can help you acquire more high-interest debt. When every cent counts, these things matter.
Building an emergency fund does not need to be difficult, but you do need to have the discipline not to touch it. Your future self will thank you.
Diving Deeper Into Emergency Funds
What is an emergency fund?
Now you may have the question, “What is an emergency fund” and I am happy to answer that for you. An emergency fund in its name hints at the fact that this is a pool of money that you would use strictly for emergencies.
Let’s go through a few examples of what may be considered an emergency.
My car just broke down on the side of the road and I need to get it towed. Yes, this is an emergency.
I just found out that I need to have my infected gall bladder removed before it gets worse. Yes, this is an emergency.
The new PS5 just came out and it costs 500 dollars but I only have 250 dollars. No, this is not an emergency.
Do you see where discipline is needed? It is up to you and your discernment to determine whether or not a situation qualifies as an emergency.
An emergency fund is something that you must make a priority to replenish when you have removed money from it. If something is not worth the hassle of redirecting funds back into your emergency fund, then it probably wasn’t an emergency, to begin with.
How much should you put in an emergency fund?
The answer to this question will greatly depend on the financial guru that you ask. It is generally advised that you save at minimum three months of your monthly expenses.
To make the calculations easier you could use the Emergency Fund Calculator linked here.
To get you to a fully funded emergency fund faster, you can save three months of your core expenses. This would exclude all of the frivolous spending like eating out or nonessential experiences.
If you are curious about ways that you can do things by yourself for cheaper and still feel fulfilled, I recommend that you check out this post.
Emergency Fund vs Savings
This is a very reasonable question that I had to research too. The difference between the two as I understand it is that your emergency fund is used for emergencies.
For example, if you had an emergency fund with $5000 and a savings account with $5000 and you needed to have an unexpected surgery, you would first take from your emergency fund.
For example, if you had an emergency fund with $5000 and a savings account with $5000 and you wanted to buy an expensive pair of shoes, you would pull from savings. You can break it down further into sinking funds, but that is the gist of this example.
Another difference to note is that there is a cap on the emergency fund. Once you hit your 6 months of monthly expenses, you can redirect the money towards savings and investments. If you carry an unnecessarily large balance in your emergency fund, the money sitting there may be doing you more harm than good.
There is no limit to the amount of money that you choose to save. After you reach your threshold, you can look into opportunities that would get you a better return on your money but that is up to you.
Savings can also be used for large purchases where you need a liquid or easily accessible cash. Some examples of this would be a down payment on a house or a car or a yacht.
Idk, I have no clue who will read this, but if you are in the position to buy a yacht please reach out. I may need to ask for some pointers.
Where should I store my emergency fund?
This is where I recommend that you do your research.
I can share that I use Ally Bank because it is a high-yield savings account where I receive more interest on the money I save every month. At my traditional bank, the returns are not as good as the ones that Ally offers.
One thing that I will say is that having your money in a trusted online banking account can make it more difficult for you to touch the money. If you can somewhat anticipate large expenses, and have a few business days beforehand that is ideal.
If it is too easy for you to transfer money from your savings to your checking, delaying the transfer might be good for you. You can also have buffer savings with your traditional bank. If you need instantaneous money, this may be the better option. The key word here is need.
Sense of Urgency
Some people are backward in their thinking about building an emergency fund. They assume that since they found a way to get by in the past, there is no emergency that they can’t handle. This may be true, but there are better ways to handle your finances. Who needs all of that extra stress?
Another thing that people may tell themselves is that they do not make enough money to have an emergency fund. There are two solutions to this problem. You can increase your income or decrease your expenses. These are the easiest ways to have more money available to save.
Please know that if you are the type of person to say, “I will start saving money when I am rich”, you are lying to yourself. Building wealth and keeping it are two completely different skills. I will also throw in that rich people do not stay rich by spending more than what they can afford on non-assets.
Please understand that having an emergency fund is not something that you can push to the future. If you want to get out of the cycle of poverty, you will have to make different decisions regarding your finances.
You’ll be surprised at what changes when you make impactful decisions like these.
Having an emergency fund is an emergency.
I have heard this from Caleb Hammer. He is a personal finance Youtuber and he has some binge-worthy videos if you are also interested in personal finance.
People tend to push something like an emergency fund to the bottom of the list when it comes to fixing their finances. This is a huge mistake.
Many people who put all of their extra towards paying off debt don’t consider that if you have any emergency that costs more than you can contribute to your debt monthly you will only increase your amount of debt. This is an important consideration.
Paying off debt is wonderful but you do not want to be at risk of not being prepared for unexpected expenses. They do come and you do not want them to deter the progress that you have made financially.
Your credit card is not your emergency fund, I repeat your credit card is not your emergency fund!
It may get you through the first few situations, but the money was never yours. The credit card company fully expects to be paid back their money regardless of what it was used for.
As easy as it is to become relaxed using a credit card, it is just that easy to fall back into consumer debt. Credit card companies make it very easy to have money accessible to the customer.
You must remember that credit card companies are not your friends. They profit from the poor financial decisions of you and others every single day.
It is in their best interest for you to use a credit card as an emergency fund because the chances of you paying it back in full with no financial literacy are low.
A credit card can be a great financial tool, but it is highly encouraged that you know the risk that you are taking on when you swipe it.
Why a credit card emergency fund is a terrible idea
- You would probably be off better financially to just pay for the expense with cash so that no debt is involved. Those who are financially informed would have the cash to cover the expense regardless of whether they choose to pay with a credit card or not.
- You would put yourself into more debt because you did not have the money to cover the expense.
- You are encouraging bad habits within yourself. If you only pay the minimum required each month and increase your balance with a large expense, you close the gap between your balance and the credit card limit.
No one regrets having a fully funded emergency fund
I would just like to note that I have never heard anyone who was prepared for an emergency complain about their preparation. It is more common to hear people complain about not being prepared enough.
An emergency fund is the foundation of your financial well-being. Not having enough to cover your cost of living is a scary place to be in.
Life happens no matter what but if we can prepare for what life may throw at us, we can continue and make rational decisions because our basic needs are covered.
Importance of Having an Emergency Fund
Having an emergency fund is extremely important. You do not want to be put in a situation where you must choose the worst of two evils.
You give yourself options when you have an emergency fund. You do not always have to default to the cheapest option because it is what you can afford. When you have the power of having options, you can make well-rounded decisions.
If you are still not convinced that having an emergency fund is essential, here is a list of benefits that I came up with for your viewing convenience:
- Peace of mind
- Prepared for the unexpected expenses
- Prevents you from going into bad debt
- Protects your credit score
- Gives you more options
- Begin good saving habits
Hopefully, you were able to learn a thing or two about emergency funds. I will say it again, having an emergency fund is an emergency.
Now that you know you need one, now is a great time to start.