Why is it so important to have an emergency fund? Emergencies are (unfortunately?) part of life, so should be an emergency fund. Whether it is for an unexpected medical bill not covered by your insurance plan, or in case your car suddenly breaks down. How do people plan on paying such bills without going into debt or starting to dip into their retirement funds?
A lot of people believe that an emergency fund is kind of *optional*. This is often the case for people which did not yet encounter a true emergency or people believing they cannot afford an emergency fund.
In fact, some studies have even shown that in the U.S. 66 million adults did not have anything saved for emergencies. Broken down by age, Generation X people were the worst:33% of people aged 36 to 51 said they had nothing saved in an emergency fund.Click To Tweet
What is an emergency fund
Strictly speaking, an emergency fund is a safety net that prevent people taking debts when unplanned events occur. It varies a lot depending on people, as some might have never been forced to use an emergency fund whereas others keep dipping into it.
What’s not an emergency fund for
Having an emergency fund is good, but problem arises when people do not really know for what they should be using their emergency fund:
- People should not be using their emergency fund for planed purchases (car, house, etc.)
- Emergency fund should also not be used for spontaneous purchases (gifts, etc.)
The only real use case should be for unplanned and unexpected events which can lead people to financial trouble otherwise.
There’s also a common misconception for a lot of people, who believe that since they have already started an emergency fund, they do not need to save anymore. This is the worst thing to do in my mind and could lead to dangerous results. Especially since people tend to save only a fraction of their income as an emergency fund. People have to get past this mentality and understand that an emergency fund is not only *required* but also only a first step to a better future!
What’s the right amount to save
The answer to this question typically differs widely among people because it truly depends (a lot!).
Some people believe that they would feel comfortable with $1,000, while other would not be willing to have less than $50,000 in their emergency fund(!). People often refer to emergency fund as a buffer for expenses, like 1-month covered expenses, up to 1-year sometimes!
In my mind, there are no good answers to the question of how much is enough. The only good answer would be to start one if you have not! I personally started late to build up mine, but I’m aiming for a 3-month expenses buffer (check out my summarized financial reports).
There is an old proverb which states “The best time to invest is yesterday. The second best time is now”. I definitely think that this one also applies to savings, especially to building up an emergency fund.
Where should I keep it
Regarding the “where” part of the question, once again this is the question to which a lot of people have different answers.
In my beliefs, the only good answer would be to have it in a separate account from your checking or savings accounts (not to feel tempted for planned purchases). But there are many good alternatives:
- In a High Interest Savings Account
- In stocks, bonds or CDs, but in taxable accounts, not in accounts dedicated to retirement
For me the best one would be in a HISA. Even with low-rates as we have now, this is still better than 0% and you get to access these funds anytime and quickly in case of a true *emergency*.
Automating your finances should be your priority number one. It’s the go-to way to increase your savings without even noticing it. This applies to retirement accounts (such as Wealthsimple), but this also applies to building up an emergency fund. There are some easy ways to fund it:
- Plan: you should be breaking down a savings goal in smalls steps. Once you’ve reached your initial goal, you can set another goal.
- Budget: doesn’t matter if it is $20 per paycheck or $1000 per month, just fund it on a recurring basis.
- Automate: direct transfer as soon as your paycheck hits your account and you will not even know it was here in the first place!
- Extra money: use extra money like bonuses, tax refunds, or unexpected windfalls to boost your fund.
Building an emergency fund takes time and discipline and some sacrifices, but in can be done. It should be done over time and in increments (which is the main reason to automate your finances!) until you feel comfortable with the size of your stashed amount of cash (1-month expense is a good start!). Despite that, it is a necessary part of creating financial stability and giving you peace of mind when an unexpected event occurs.