An emergency fund is money you set aside to pay for unexpected expenses. Life will throw you some curveballs along the way, may not be today or tomorrow but there will be unexpected emergencies and and emergency fund will help you be prepared.
Here’s why you need one
A job loss is probably what comes to mind when you think of an emergency. Think about Covid. When the pandemic started, a lot of people lost their jobs, lost their medical insurance, some got sick and had no money to pay their medical bills. If you are not prepared, you will end up in medical debt or borrow on your credit card. Although you can’t know what kind of emergencies you are likely to face, here are some examples.
- Job loss – If you lose your job, you need to have sufficient money to cover expenses while you find another source of income. While you can cut all your discretionary expenses, your mortgage, rent, groceries, utilities still need to be covered. Subscribe to my website to get a copy of my budget template that can help you understand all your expenses.
- Medical conditions – A sudden onset of a medical or dental emergency can set you back financially. Couple that with a job loss and it will double or triple your stress levels.
- Expensive home repairs – A HVAC replacement or roof replacement can cost a few thousand dollars. Our air conditional broke down in the middle of a hot summer and cost us ten thousand dollars. Luckily our savings were able to cover the replacement.
- Car repairs – Car repairs can be expensive, especially if you drive a high-end car. An alternative is to buy a new car which may increase your monthly expenses in insurance, car payments, etc.
- Death – Funerals can be expensive. Even if you have insurance coverage, it takes time to receive money from the insurance company and having an emergency fund certainly helps with the stress.
- Unexpected tax bill – If you have paid sufficient taxes during the year and are unaware of how much you owe the IRS, this tax bill may come as a big surprise in April.
- Debt – if you already have a lot of high interest debt, you will find it difficult to get back on track if you need to borrow again for any unexpected expenses.
How much emergency fund should I have
I recommend keeping an at least 3 to 12 months of your monthly expenses. Use my calculator below to find out how much you will need to save based on your risk tolerance.
Emergency Fund Calculator
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Where should you keep your emergency fund
While a lot of people use regular checking accounts, I recommend using a high yield savings account or a money market account separate from your checking account. We are in 2021 and still in a low interest rate environment. However, a money market account offers a slightly higher interest rate than a regular checking or savings account. Here are my 3 main reasons for opening a money market account for your emergency.
- Your emergency fund will be separate and out of reach for regular transactions. You will not be able to write checks from this account. Out of sight is out of mind and you will be less likely to spend this money on your regular expenses.
- You will still earn some interest on this money.
- It will be FDIC insured up to $250,000.
Why not use a brokerage account instead
Never put your emergency fund in the stock market. The stock market is subject to fluctuations, and sometimes these can be wild. You need your savings to be in a safe asset that you can depend on in a true emergency. You definitely don’t want your savings to lose their value to stock market volatility.