Defend Against the Unexpected: How to Build an Emergency Fund

Life is full of uncertainty.  Cars break down, we get sick, layoff notices come, roofs leak, water heaters burst, and bones break.  These and other events strike without warning.  IDebt Cycle Graphicf you do not have money set aside to handle these situations, you will likely be forced to rely on high-interest debt such as credit cards or payday loans.  The high-interest rates make it hard to pay back the debt and you get trapped in a vicious debt cycle.

Your best defense?  Develop and maintain an emergency fund.  An emergency fund is cash that is set aside in a protected account that is used as a last resort in the event of a financial emergency.  Some people refer to the emergency fund as a “rainy-day account” or a “what if” account.

If you are just beginning down the road to better financial management and are struggling to pay off high-interest rate debt, it seems hard to justify cash sitting around earning maybe 1% (or less) in interest.  If you are trying to grow your investment accounts and see your investments earning 6% or 10% a year, it may seem silly to put cash into an account that earns only 1%.

However, the emergency fund is a highly liquid account such as a savings account or money market account for a reason.  If something happens and you need extra money, you do not want to take on debt (again!) or face penalties and time delays in accessing your money from an investment account.

How big should my emergency fund be?

Save for Rainy DayFinancial experts vary on this question.  Dave Ramsey says $1,000 as a minimum starting point and as you are paying down debt.  Paying down high-interest debt will often make a greater impact on your financial situation then building a robust emergency fund due to the low interest earned on the savings and the low frequency of needing to dip into the emergency fund versus the high interest being paid on debt each month.

The general emergency fund recommendation is 3-6 months of expenses, but some even say 9-12 months of expenses is ideal.  Note:  This is months of expenses, not income.  Calculate the minimum amount you need to cover bills, debts and living expenses for one month, then multiply that expense number by the number of months you want to have in reserve.

My answer?  Consider your individual variables.

Ask yourself the following questions:

  • Is my household a single income household?
  • Is anyone besides me dependent on my income?
  • If I lost my job, could I live on unemployment or would I need to draw down my savings to survive?
  • How fast do I think I could get another comparable job?
  • Do I have housing options (friends/family) if I can’t afford to pay rent? How viable are my housing alternatives?
  • Am I renting or do I own a home?
  • Could I get a roommate or rent a room out if I needed to?
  • Do I have any ongoing medical needs that I need to pay for?
  • How old is my car? Is my car due for maintenance or repairs?
  • What are the deductibles on my insurance policies? Consider auto, renters/homeowners, and medical.
  • What other savings do I have?

Someone who owns a home, is supporting a family on a single income, and works in a field where it is difficult to find a comparable job will need a much, much larger emergency fund than someone who could potentially move in with his or her parents and easily live off unemployment.

If you have a newer, very reliable car and do not own a home, then $1,000 is probably a good starting point.  When I began recovering from my rock bottom financial moment (read about it here), I personally wanted a minimum of $1,500 as my starting point ($500 for emergencies and $1,000 to pay my auto insurance deductible if necessary).  From there, I slowly built up my emergency fund ($20 a month) as I was also paying down credit card debt.

Pick a minimum amount that makes sense to you for your circumstances and then build your fund slowly with monthly contributions of whatever you can afford.  Stop funding the emergency fund once you’ve reached your pre-determined goal.  While an emergency fund is essential to healthy finances, saving too much in a low-interest account is not conducive to long-term financial health.

Where should I keep my emergency fund?

Penny Under Mattress Giphy

Not under the mattress!  All joking aside, keep your emergency fund somewhere liquid, but not in your checking account.  I like to have a savings account that is solely for the emergency fund so that I do not confuse the funds with anything else.  When setting up your emergency fund, you also want to find the best interest rate possible.

I like to keep my savings account at an online bank.  The money is federally insured and I can access the money within a day or two if I need it, but I can’t access it instantly.  Keeping the emergency money at the online bank provides a double mental barrier against dipping into the money:

  1. I don’t see the money sitting there when I log in to my regular accounts at the credit union, and
  2. I have a small built in “cooling off” period where I would have to wait for access to the funds.

These measures prevent me from impulsively spending my rainy-day fund.  Another benefit of online banks is that they generally offer higher interest rates.  Other financial experts recommend a money market account.  What should you do?  Find a relatively safe and accessible account that offers the best interest rate possible without a lot of risk.  On the day you need to access your funds, you don’t want to find out it suddenly shrank 20% because the stock market had a bad day.

Want to find out more?

Emergency lightEmergency funds are one of the basics of personal finance and the internet is full of articles about them.  Over the last few years I’ve read a lot about emergency funds and I’ve compiled some of my favorites.  The articles below present useful and unique perspectives on emergency funds that may help you determine what is right for your family and your situation.

  • Making sense out of competing expert advice

    • This article from the Lifehacker website compiles competing advice from various personal finance gurus.  This article offers a lot of food for thought to consider when setting up (or fine-tuning) your emergency fund.
  • Can you have too much emergency fund?

    • This article from Get Rich Slowly focuses on a problem most of us probably don’t have – an emergency fund that’s perhaps too big.  But I think this perspective offers important insight and will help you determine the ultimate size of the emergency fund that’s best for you.
  • What qualifies as an emergency?

    • Great article from The Balance that helps you redefine what, exactly, an unexpected expense is.  It has good reminders about making sure your budget accounts for infrequent, but expected, expenses such as annual premiums, annual eye exams, home maintenance, etc.  A reminder to use your emergency fund for emergencies.


Have you had any challenges establishing an emergency fund?  Do you have any tips to share?  Comment below!