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We’ve all heard the financial gurus out there telling us we need 3 – 6 months worth of expenses, 8 months worth of expenses, and even up to 2 full years worth of expenses sitting in a safe, accessible account in the event of an emergency. I’d like to dissect this advice a bit and get to the bottom of where it comes from and why you should or shouldn’t follow it.
You NEED An Emergency Fund!
The #1 rule of personal finance is that you NEED an emergency fund. The question then becomes, how much of an emergency fund do you need? Let’s first be clear about what an emergency fund actually is. An emergency fund is not intended to replace your monthly income – rather, an emergency fund is meant to cover your monthly expenses in case of, well, an emergency. Monthly expenses and monthly income can be vastly different – and hopefully are in your case. The bigger gap you have between income and expenses, the more wiggle room you have in your budget and the more easily you can handle unexpected expenses and sock money away into an emergency fund.
What Is Not An Emergency
Before tapping an emergency fund, you must first understand WHAT constitutes as an emergency. Occasional expenses like insurance premiums, car inspection costs, vet bills, and home/car repairs/maintenance are not generally considered emergencies because they’re predictable. Ideally, financial gurus will recommend having a separate account set aside to cover the occasional yet predictable expenses like insurances and maintenance, assuming you cannot cover them with monthly cash flow.
Some unpredictable emergencies can also take you by surprise. For example, while you may know how much goes into your insurance and car maintenance, a car accident can happen without warning. And this can be a source of a financial headache which you may need your emergency fund to cover. Of course, you can get some compensation in case of an accident if you hire a good lawyer and understand the laws regarding car accidents. But a car accident is still an unpredictable emergency worth preparing for.
The following is a list of items that definitely do NOT qualify as emergencies – regardless of who you ask.
Basically, if you need to tap your emergency fund to purchase any item below – you can’t afford it.
- Buying the latest fashions to adorn your pampered butt
- Jet-setting to the Caribbean for a vacation
- Dinner and drinks with friends
- A new car
- A newer car
- A house
- A bigger house
- Furnishings for your apartment or house
- The latest iAnything
Awesome coasters for our pub table were NOT emergencies
What Is An Emergency
The following list is comprised of full-blown, four-alarm emergencies, as well as the smaller stuff that still falls within the umbrella.
- You lost your job and need to pay your living expenses until you find a new one
- Rent/mortgage
- Food
- Utilities
- Cable – No. Cut the cable.
- A Car Accident
- You develop a medical condition and require treatment
- You are in a car accident and need to pay deductibles and repairs
- Major home repairs – some argue these are occasional/predictable and not emergencies – I think they can fall into either category.
Pizza in Philly – another non-emergency
What About Car Accidents
Some car accidents are minor fender beners. Unfortunatley, others are not. For some, a car accident can be a traumatic event.
Some unpredictable emergencies can also take you by surprise. For example, while you may know how much goes into your insurance and car maintenance, a car accident can happen without warning. And this can be a source of a financial headache which you may need your emergency fund to cover. Of course, you can get some compensation in case of an accident if you hire a good auto accident attorney baltimore md and understand the laws regarding car accidents. But a car accident is still an unpredictable emergency worth preparing for.
Reasons To Not Have An Emergency Fund
- You’re not responsible for other people
- You could easily and quickly replace your current income
- You still live with your parents with no monthly expenses
Side Note: You must fall within All of the Above to qualify for not having an emergency fund.
Related: Inexpensive Family Staycations Are More Fun Than You Think
We Err On The Side Of Caution
In case you’re wondering, Mr. MMM and I cast our vote for somewhere South of Awesome for emergency funds. I don’t think anyone will argue that emergency funds are for suckers per se; the issue of how much and where to stash the extra cash is the Great Debate. Having a fully-funded emergency fund sitting in a low interest-bearing account is painful for some people. For some, it’s preferable to have fewer dollars stashed in such an account and access to a much larger invested stash, should a major emergency occur.
We err on the side of caution with our emergency fund. Our cash reserves equal substantially less than 2 years worth of income, however, we’re fortunate enough to be able to cash flow most small emergencies with our monthly income. For the bigger stuff, we sit on the lower side of the recommendations, with that money in an easily accessible money market account.
We also have a few big wins in our corner – One being that I would be able to replace my income fairly quickly if I were to face a job loss. We’re total DIKs and live on only one income. And, we have a sizable amount of money invested in taxable accounts that we could liquidate in the event of a catastrophe. Fingers crossed!
Related: Early Retirement Will Take A Little Longer If You’re Total DIKs
What do you think? Do you have an emergency fund that could float you for 3 months, 6 months, 8 months, or a year or more? Do you think a big emergency fund is necessary? How do you handle unexpected expenses?
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Feature Image: Jason Droege Photography (jd_visualz on Instagram) – Stunning natural photographs of Lancaster County.
39 Comments
We do have a designated emergency fund in the event of job/ income loss. My original goal was to have cover for six months but I’m shooting for a year now. A few friends were layed off and it took anywhere for 9-12months before they got employed again.
Because of the way my mind works, I save separately for expected and unexpected things. So I have lines for job loss, car maintenance, insurance, vacation, life happens etc. Most of this is in one account but just tracked separately.
I like having separate accounts, as well. Wow, 9 – 12 months to find another job. Maybe I need to re-evaluate how long it would actually take me. Yikes.
I suspect it’s based on the city I live in. Those two are my worst stories among my friends. Being a worrier I tend to use worst case to plot my course 🙂
I have about $10k in savings which acts as my emergency fund. I try to stay around $10k because I want to be prepared if something goes wrong with my house. I have an older furnace and water heater and if they were to go out, then I’d have to scramble to figure out a way to pay.
Also, it gives me peace of mind – more money in the bank helps me sleep better -less stress 🙂
Peace of mind is priceless. What you’re doing sounds like a good plan (to me :).
I’m pretty similar to Erik, in the amount I keep in savings and my reason. As for a true emergency, my wife and I each have IRA accounts, in which our contributions could be withdrawn. We each work in stable fields, and we live off only one salary so things would really have to go off the rails for us to need a big emergency fund.
I agree with this line of thinking. If you have your bases covered the way you and your wife do, the chances of having enough to handle most emergencies is close to 100% Besides, what are the chances of having a catastrophic emergency? IMO, close to zero.
We don’t hold much of an emergency fund at all, the opportunity cost of sitting in loss of cash is just too high. We’ve developed “alternative” emergency funds we can access like our taxable brokerage account and a home equity line of credit we could open, etc. Similar to you folks we support ourselves on one income although we aren’t DIKs about it, we have one kiddo and another coming along soon!
You made me laugh this morning. We try not to be hardcore DIKs, it just comes with the territory 😉 Yeah, we don’t like the idea of losing out on earnings because we have a ton of cash sitting around in a low interest-bearing account. I think, as long as you can access the money, you’re covered. Besides, how many catastrophic emergencies are there where you need to support yourself for a year or longer? The probability is quite low.
We don’t have more than a couple thousand dollars in an emergency fund at this point for several reasons.
1:We are now both fully employed with secure jobs and a decent amount in disposable income each month.
2:We have each shown that we’re willing to hustle for cash in a pinch, whether selling things on eBay or working a serving job on the side.
3: We’re using every dollar we have to pay off our debts, and keeping extra cash has a high cost in the name of interest.
Once we have our debt paid off and are looking into home ownership, we’ll definitely beef up our savings account to get us through anything that comes up. Great post!
Ryan
Awesome! I think too often we’re “scared” into thinking we need a year or more worth of expenses sitting around in a savings account earning next to nothing. The only exception I can reasonably come up with is if you’re leveraged to your eyeballs AND you lose your job OR you have an unforeseen medical expense. Thanks for sharing!
We’re teasing disaster with ours… We’ve only got $1,000 in ours right now while we’re paying off debt. Talk about motivation to get it paid off! We’ve been fortunate enough to be able to cash flow several emergencies that were over the thousand mark in the past year with our EF’s help, so hopefully we’ll be okay until we’re done. As soon as that last payment is made, though, we’re bumping ours up to at least 3 months’ worth of expenses; I can’t bite my nails any shorter!
I do think that most “emergencies” are handled with a thousand or so dollars. It’s the BIG stuff, like a job loss or medical expenses that requires excessive savings sitting around. It sounds like you’re on the right track!
I currently have about three months saved in a low interest account. I don’t currently have any investments besides my 401(k) so the little interest I get there is benifical.
I would also suggest we take in consideration of how far ahead we are on payments if something happened. For example – I’ve been working to pay off a student loan. I’m over two years ahead on that. So God forbid something happen – I don’t have to worry about paying that for a while.
That’s another way to approach an emergency as well! Paying ahead on monthly expenses – like student loans – is essentially an fund in itself.
Right now I’ve got about $5k in my savings/emergency fund, with the bulk of excess funds in my brokerage account. I’m not too worried about job security (every company needs accountants) but more concerned with appliances dying or something happening to my house.
The caveat is that I have more than enough in my HSA to cover my annual out of pocket. So at least medical costs would be covered. If I didn’t, my savings account would have a larger balance.
Since I’m thinking about retiring in 2026, I’m going to take all future bonuses and stick them in my savings account, with the idea that I’d reach 2 years worth of living expenses by then. But I really don’t see the point in having that much just sitting in savings today.
It sounds like you have all your bases covered. I think a one-size-fits-all recommendation is silly and it really does depend on your individual circumstances. I guess the gurus just try to make it easy.
We have three categories with separate accounts. Auto, medical and everything else. This keeps it divided for the most common emergencies without touching the other accounts unless we have a full blown emergency (job loss). At that time all three accounts would still pay their designated categories. Both an unexpected ER visit (last weekend – O fun) or paying medical insurance monthly premium during a job loss both can use the same account.
Sounds like an awesome plan! I love hearing how everyone else plans handles their e-funds. Thanks for sharing!
We have a large stash of cash but it’s not only for emergencies, it’s for a land purchase. I think if you have investments that can be liquidated within a day or two it’s not necessary to have a huge wad of cash but I’d also want to have a high credit card limit in case of a real emergency that can’t wait even a day.
That’s a good point, too! If you have the money invested, you can always use a cc in a pinch and just pay it off when the bill rolls in. Did someone say huge land purchase? That sounds like fun!
I’m a fan of the Emergency Fund, but after reading this article I think we have too much saved (4 months of expenses). I could lose my job yes, but I feel fairly certain I could get another job in less than 4 months. Looks like we’re paying off the mortgage sooner! Thanks for the inspiration!
Awesome for paying off the mortgage sooner! Two thumbs up!
I don’t quite have an emergency fund and have alternative emergency funds, like having a taxable account loaded and ready to withdraw and cover my month’s expenses that I’ll put on my credit card.
However, I do recommend starting an emergency fund for people (usually university graduates) just starting out on their personal finance journey and then possibly transition to utilizing credit cards as their emergency fund (as long as their financially responsible).
Yeah, there is definitely a benefit to having some cash sitting around so you don’t fall into credit card debt. Good recommendation.
We have just started building an emergency fund last month. My husband lost his job at the end of February and if they hadn’t given him a generous severance package we would have been so screwed. Scary to think about.
I’m glad you got the severance! Sounds like you’re on the right track. Congrats on building your e-fund and peace of mind at the same time!
People overestimate the good times, and underestimate the bad times. Emergency funds are a good thing, and the amount should be based on what stage of financial independence someone is in. The earlier in your journey, the higher the fund. At least that’s what I say 😉
Going from big to small, depending on where you are on your FIRE journey is definitely solid advice!
Good post. We keep approx 10k in our emergency fund. My wife really enjoys the peace of mind of that cash around. Sucks to not being makin any income off it but she’s happy.
Peace of mind is key. That is the variable you can’t measure. We are working on eliminating our mortgage, even though we know we could likely make much more by investing it. But, it’s the right thing for us.
The thing is an emergency fund can come in many forms. On the extreme end or risk you have those using a home equity line of credit or pure cash. In the middle is CDs to Roth IRA and everything in between. But either way there is still some sort of backup plan.
That is absolutely true!
Harry Browne suggested in his Permanent Portfolio a 25% of cash. Not as an emergency fund but as an investment (which is not the same). Assuming the 4% rule (saving 25 years of expenses), it means 8.25 years of expenses in cash. That’s huge.
I think it is too much, but he was quite good providing arguments supporting it. It makes me think that 2 years are not wrong.
In addition, I would feel unsafe having a “credit line” instead of cash. Cash is ready there, but credit is something that could be denied.
Interesting post, by the way. Thank you.
My wife and I have kept $1000 as an emergency fund up until a few months ago. We are following Dave Ramsey’s baby steps, and until we get the last of our debt paid off that is our plan. We are expecting our first baby in August, and have stopped paying off debt until the little one arrives in order to stock up on cash to have on hand to cover anything we aren’t anticipating with the birth.
Having only $1000 set aside is definitely motivation to pay down our debt faster; we have had to get creative a couple of times to cash flow some emergencies, but have always found a way to make it work and avoid more debt. Once our debt is paid off, we will probably beef it up to around $10k-$15k.
Congrats on the impending birth of your new baby! That’s always exciting and it definitely gets you motivated to get all your ducks in a row, at least it did for me. I like Dave Ramsey’s Baby Step system. I’m not sure why people are so hard on him. $1k is a good start and will handle most little things. I’m glad to hear it’s been working out for you and your wife. Keep moving forward. That debt will be annihilated before you know it!
SO disappointed you didn’t include “dragons and other indications of your totally metal lifestyle” under the Emergency category. 😉 Awesome advice as always.
There is a gray area between operating costs to cash flow within a regular monthly budget and the emergency fund: capital expenses. I know that I need to reroof my principal residence, repaint my fourplex, and probably reroof the fourplex, too. These expenses are looming since it’s been decades since I last paid for them. But they haven’t failed yet. Thus cash I’m holding to hedge against a black swan market day needs to do double-duty as a repository for funds to pay for capital expenses.
My wonderful, beautiful, beloved Mercedes was on the capital expenses list until a @#$%^#& Honda totaled it. Buying its replacement went from deferred capital expense to “emergency.” But it didn’t feel like an emergency since replacement costs were already earmarked.
You are definitely in the minority, budgeting for those expenditures. Sorry to hear about the Mercedes! But, totally (no pun intended) glad you funds earmarked for its replacement. Zoom zoom zoom!