Emergency Funds 101

Your son’s foot slips while backing into the driveway and he crashes right through the garage door.  A water pipe bursts and floods your basement.  Your furnace dies in the middle of winter. Your company is downsizing and you suddenly find yourself out of a job.

Life is full of financial emergencies like these, which is why it’s smart to establish an emergency fund to cover unexpected expenses or a loss of income.

But how do you go about setting up an emergency fund?  Where do you get the money from?  Where do you keep it?

Have no fear…we’re going to answer all of your questions about emergency funds below.

How Big of an Emergency Fund Do You Need?

There are many opinions as to the optimal size of an emergency fund.  One common rule of thumb is that it should be big enough to cover three to six months of your living expenses.  Some people suggest you need at least a year’s worth of living expenses while others believe you can get by with just $1,000.

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We recommend a minimum of three months expenses, but ultimately the size of your emergency fund will depend on your own personal circumstances and monthly bills.  Someone who is frugal and doesn’t have many expenses wouldn’t need as much as someone with a hefty mortgage, multiple car payments, and a host of other bills to pay.

Of course if you did suffer a long-term financial emergency, such as a job layoff, you’d want to trim your expenses to the bare minimum to make your money last as long as possible.  You don’t want to miss mortgage payments, so it could be time to scale back your cable package and stop eating out every Saturday night.

Do you have any dependents?  The more people who are relying on your paycheck the larger your emergency fund should be.  This is not only because you have more mouths to feed, but also because there are more opportunities for an emergency to take place.  My kids have made several trips to the emergency room and while none of them were particularly serious they were all expensive.

How to Fund Your Emergency Fund

Perhaps the most frustrating part of creating an emergency fund is finding money to get it started, especially if your budget is already stretched to the limit.  Here are some tips to help you build up an emergency fund no matter what your current resources are.

  • Start small.  Putting away $20 per paycheck may seem futile at first, but it is important to get the ball rolling and start saving something.  Thanks to compound interest, even small amounts will grow over time.  And you can always increase your savings amounts when you can.
  • Get a bonus at work or a fat tax refund check?  Put in towards your emergency fund instead of spending it.
  • Get a part-time job.  It doesn’t have to be a lifetime commitment, but a second job can give your emergency fund a healthy boost.  To stay motivated you can set a goal such as, “I’ll work two jobs until my emergency fund account reaches $5,000.”
  • Sell your extra stuff.  We all have stuff stored around the house that we know we’ll never use again.  Why not turn your trash into cash?   You could hold a yard sale, sell it to a consignment shop, or sell it online at sites like eBay or Craigslist.  My wife found a neat Facebook group where moms from our area post items for sale.  She’s already sold a handful of items and made about a hundred bucks on stuff I was going to throw away.
  • Dig under couch cushions and car seats.  Keep a jar at home and empty all the spare change from your pockets into the jar every day.  You’d be surprised how quickly it will add up and once the jar is full you can deposit it into your emergency fund.

Where to Keep Your Emergency Fund

Emergency fund money should be kept where it can earn some interest and where you can access it quickly and without penalty.  It also needs to be somewhere safe.  Remember, your emergency fund is for saving, not investing.

Where NOT to keep your emergency fund:

  1. Under your mattress.  While we do recommend stashing a small amount of cash (say $200) somewhere around the house for minor emergencies, keeping large sums of money under your mattress or in a drawer is foolish.  It could easily be stolen or destroyed in a fire or flood.
  2. The stock market.  Remember, you want your emergency fund to be safe and easily accessible and stocks are anything but.  You’ll incur fees to sell stocks and what if the market is down when you are forced to sell?  Bad investment choices could sink your entire fund in no time.
  3. Certificates of Deposit.  While CDs are safer than stocks and they do earn interest, you will usually be charged early-withdrawal penalties if you have to cash them out early.

The Best Place to Store Your Emergency Fund

A high-yield online savings account offers the perfect balance between safety, liquidity, and earnings.

Your funds are FDIC insured so you won’t have to worry about losing money like you would in the stock market.

Your money is easily accessible through a bank transfer, or if you have a checking account set up you can even write a check or use an ATM to withdraw money.

You’ll earn interest.  You certainly won’t get rich given current interest rates but at least your money will be working for you and growing a little.

We have our emergency fund in a Capital One 360 Savings Account and we recommend you do the same.  It’s easy to set up and there is no minimum balance.  If you want you can set up automatic deposits to make sure you contribute to the account every month and keep it growing.

Interest rates are much better than those found at traditional brick and mortar banks, and you can set up multiple sub-accounts and label them however you like.  Having multiple “buckets” to place your savings helps you track your progress towards various savings goals.

You can go online anytime and check your balances and transfer money around between sub-accounts and even to and from a traditional bank account.  And if you open an online checking account you can write checks or withdraw money from an ATM.

Obviously the combination of safety, liquidity, and earning potential make a high-yield savings account the best place to keep your emergency fund.  Click here now and you can sign up for a Capital One 360 savings account and start building your emergency fund in just a few minutes.

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Mike is a freelance writer and blogger who specializes in finance and parenting topics. He is a dedicated husband and father of three who is obsessed with creating multiple streams of income and building wealth so he can achieve true financial freedom for his family. Like what you're reading? Subscribe to our free RSS feed and follow us on Twitter.

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Comments

  1. says

    I’ve had an emergency fund ever since the first time I needed it and it wasn’t there, many many years ago.

    The biggest problem I’ve found is where to store it. High yield savings accounts just aren’t, in today’s economy. I’ve taken to laddering CDs for the majority of it, for example, 3 3 month CDs staggered a month apart, so if I need the money, I just stop the automatic rollover, and at the end of the month, another CD is ready to cash out for next month’s bills if I need it. Not much better than a savings account, but every little bit helps.

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