If you’ve read any decent books or blogs about personal finance, budgeting, or anything money, I’m sure you’ve come across the term “emergency fund.” It sounds great – a bunch of money you can use on emergencies as needed. Who wouldn’t want that? But then it comes with all of these “rules” and “expectations” and it can be super confusing. And no one wants that. That’s why I’m breaking it all down for you, right here, right now.

What is an emergency fund, really?

An emergency fund is literally just money that you put aside to be used only for emergencies. Plain and simple. It can be a separate bank account (I recommend that) or money within your regular accounts that you know is separate.

Why bother with an emergency fund?

Nothing is more damaging to your quest to build a nest egg than accumulating debt. And a great way to accumulate debt is to not have money available for emergencies.

For example, a friend found herself having to go to the hospital in the 2 weeks that her husband was between jobs, and therefore without health insurance. She’s fine medically now, but now they have $6000 in medical bills! If they had some emergency money available, they could pay it off right away. But they don’t, so they aren’t just paying that $6000, but the interest on it, too!

I have seen people struggle to buy plane tickets for a loved one’s funeral. Or to fix a leaking roof. Or to not be able to buy food when they lose their job. No one wants to be in those positions.

I’ll give you a great example in a bit of someone who went from struggling without an emergency fund to…. well, read on and you’ll see!

Does it have to be called an emergency fund?

Some people don’t like that term. If for whatever reason you don’t like the name, change it! Call it your “just in case fund” or your “ice cream with sprinkles fund.” It really doesn’t matter, as long as you have some money set aside.

How much should be in it?

Ah, now we get into the “difficult” questions. I put “difficult” in quotes because I’ve seen a lot of people struggle with this, but when you break it down, it really isn’t difficult to figure out at all.

You might have read that you should have 6 months’ worth of expenses in your emergency fund. Or 1 year. Or $5000. But those are general numbers. Let’s talk about you.

First, how much do you spend each month? How much of that could you easily cut out if you had to? Maybe you can’t get rid of your rent, but you could go out to fewer concerts. Figure out your reduced but realistic budget. It should be something you can live on for up to a year.

Now, if you lost your job tomorrow, how long would it take you to find a new job? Be realistic. Then add 1 month to that, because it could take 2-4 weeks before you get your first paycheck. Then add a few more months because life never goes as we expect it to.

So now we know that you need at least enough money in your emergency fund to cover your reduced budget for the time you’ll be unemployed. Let’s say your reduced budget is $2000 per month and you think you could get a paycheck again in 5 months so you use a safety number of 7 months. That means you should have $14,000 (because 2000 x 7 = 14,000) saved up.

Make sure you consider your spouse or partner’s income. Can you live off of one income if you need to? That could affect how much you need to save in case of unemployment. Calculate how much you would need to save if the higher-earning person lost their job.

But wait, there’s more! Do you have any very large and unpredictable potential expenses? The most common ones are a house and children. If so, you need to put more money into your fund. What if you suddenly have to replace the roof of your house? Chances are that you won’t have to do this while you’re unemployed, but that’s a large expense and you need to make sure you have the money for it. You’ll see why in the example below.

Finally, do you have a high deductible health insurance plan? If so, make sure you have enough in your fund to cover that deductible, in addition to money to cover a period of unemployment. If your deductible is $10,000, one unexpected hospital stay could cost you a lot all at once. Be sure you have that money available! (If you have a high-deductible plan, you have access to an HSA, which is a great way to save up money for your deductible. If you don’t have access to an HSA, you’ll need to save this money with the rest of your emergency funds.)

So you’re going to take your reduced budget and your potential unemployment and multiply those numbers. You’re going to add in enough to cover your high deductible health insurance plan and then some. And then you’ll add in enough to cover one large house/child/other expense, because the odds are good that you won’t have more than one of these occur at once. Now you have your number – congratulations!

But this is too much, isn’t it?

The amount of money you need to have in your emergency fund is going to feel like a lot, especially if you’ve never done this before, but it’s necessary. When you have an expensive emergency (and over the years, we all have several of these) you’ll be glad you have it! For now, start small.

Right now, aim to put $1000 into your emergency fund as soon as you can. That’s enough to cover smaller emergencies. Once you have that, you can slowly build it up some more. Set reasonable goals for each additional $1000. How much time you need is specific to you, so do what feels right.

If you’re having trouble saving, start very small. Put $1 per week into your emergency fund this month. Next month, make it $2 per week. The month after that you can contribute $3 per week. Keep it up, and one year from now your fund will have $312! That’s a great start! Keep increasing the weekly savings until it feels right, and contribute until your emergency fund reaches your goal.

Yes, it’s tempting to put all of your savings into other things. Saving for retirement feels safe. Saving for a vacation feels fun. Saving for an emergency fund is boring. I won’t pretend that it’s not. But it’s necessary. When you hear Marisa’s story, you’ll understand why.

When to spend the emergency fund

There are so many times we need a little extra cash for something, and it’s tempting to borrow that money from the emergency fund. The problem is, even when we think it’s ok because we’ll replace that money with our next paycheck, something gets in the way and it doesn’t happen. Or it’s delayed. Or it starts a new habit that’s hard to break.

Just. Don’t. Do. It.

Your emergency fund is only for emergencies. Springsteen tickets aren’t an emergency. Fixing a flat tire is an emergency, especially if you have to use your car to get to work. Upgrading to the newest iphone is not an emergency. Buying a last-minute plane ticket to take care of a very sick loved one is an emergency. Resist all temptations and spend this money only on emergencies!

And then, as soon as you spend it, start putting money back into the account again to replace what you’ve spent.

Where to keep emergency money

It’s important that you have ready access to your money when you need it. Everyone’s situation is different, but chances are this is all you need to know:

Put your money into a checking or savings account to have easy access to it. Boom! Done.

But if you’d like to try something else, and only if you have a credit card that you pay off in full every month then you can try something else. You know that you’ll pay off any emergency charges to your credit card at the end of the month, so in an emergency you can put a charge on your credit card. That means it’s ok if you need a few days to access your money. And that means you can put your money into a breakable CD, or even invest it. Of course, if the market is down at the time that you need your money, you could end up losing a lot, so I wouldn’t recommend doing this. You could also mix it up, like putting part of your emergency fund into a savings account and part of it into a breakable CD.

Whatever you do, just make sure you can get to your money when you need it. Often in an emergency, time is a big factor.

And like I said above, you can put some of your emergency fund into a tax-deductible HSA if you have one. That can cover some medical expenses.

Marisa’s story

This all sounds nice in theory, but it’s not like it really matters in the real world. Or does it? FreedomWhen it comes to emergency funds, my friend and client, who wants to be called Marisa in this post, learned first-hand how valuable they can be.

When we started working together, Marisa had a lot of credit card debt. A large chunk of it came from an unexpected problem with her water heater. She didn’t have an emergency fund or much money in her checking account, so when the bill came, she put it on her credit card. She couldn’t pay it off right away, so those huge interest charges built up. She just couldn’t get ahead of it.

As we worked together and Marisa paid down her credit card debt, I encouraged her to start an emergency fund. She was hesitant to put money towards it, but finally agreed. We took part of her tax refund and seeded the first $1000 of the account. She slowly added to it while she paid off her debt.

She protected that money. When her dishwasher broke, she washed dishes by hand. When her stove started acting up, she used the burners that worked better. But when her fridge died, that was the final straw.

Knowing she had her emergency fund available, Marisa quickly shopped around and considered her options. She got a good deal by buying all 3 at once: the stove, the dishwasher, and the fridge. She paid $1500 in cash. She emailed me:

I paid in cash.  Crisp, green dollar bills.  That was my largest cash purchase ever.  It felt great.  🙂  The guy ringing me up kind of acted like he forgot what to do when he gets paid in cash.  We had a good laugh….  Saving does pay off.

She walked out of that store and didn’t owe a dime on any of her shiny new appliances! Wow!

Compare that to the year before, when she was still paying off the credit card bill that had built up from that darn water heater several years earlier. What a difference! She felt so free!

But Marisa wasn’t done. She had one more thing to do. As soon as she bought her new kitchen appliances, she began putting money back into her emergency fund to build it up again.

Now Marisa has a solid, healthy emergency fund so when something goes wrong, she doesn’t panic. She doesn’t go into debt. She takes out her debit card and makes the payment.

Do you want to be a water heater chick or a fridge chick?NestEggChick

Which situation would you rather be in? Would you want to put an emergency charge onto a credit card and spend years paying it off? Or would you rather put aside a little bit of money each month so that when you need it, it’s ready for you?

Most of us are in a water heater situation at some point. But wouldn’t it be better to be a fridge chick?

3 seconds

It’s SO important for everyone to understand money basics like emergency funds! It upsets me SO MUCH that this isn’t covered in school. It should be taught in an age appropriate way in every grade!

You might not have learned it back then, but you can learn it now. Take 3 seconds now to sign up for my mailing list by just entering your email address at the top of the screen. Let me show you how to build your nest egg so you have the money you need, when you need it. Then please take a moment to share this post, so your friends can learn how to cover their emergencies, too. I believe there are few better gifts we can give than teaching one another how to be happier and more in control of our own lives. Understanding money and building a nest egg are a big part of that!

Then, check out this 1-page printable cheat sheet of 5 quick and easy ways to save an extra $100 this week, and use that money to start and grow your emergency fund!

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