Emergency Fund Explained

Emergency Fund by Tax Credits on Flickr

Emergency Fund by Tax Credits on Flickr

An emergency fund is the most important and the most boring aspect of personal finance. It is important because it provides a sense of security knowing that you have money in place to take care of almost any problem. It is boring because it takes so long to build, it has to sit in a place that does not put it at risk, and it really sucks to look at that much money and not be able to do anything with it.

Increase Your Checking Account Balance

Even before I knew what the term meant, I always had an emergency fund. This concept is something I do without thinking. With my first job, I stocked up two hundred dollars and kept this amount as the bottom floor of my checking account. Basically $200 became my $0 balance. To this day I still do this same concept. The amount has just increased. My checking account constantly carries $1,000 as my zero balance. This concept was the start of my emergency fund. To figure out your amount, balance out a number that you can afford to keep and that will cover most immediate expenses. An added benefit of keeping a small emergency fund in your checking account is that you offer your own overdraft protection. There are no fines for using your own.

Expand Emergency Fund

In order to receive the full benefits of having an emergency fund though, you have to take it further. You need to calculate out the least amount that it would take for you to survive for a given time period if the worst happened (loss of a job, sick family member, car accident, etc.). The general advice is to start saving up for 3 months’ time. This is a great starting number because it provides a big enough cushion to feel the security and it does not take forever to meet.

Personally I aim for 6 months saved. I carry two mortgages and have three young children all relying on my income. Three months just does not feel safe enough for me. You need to figure out the number of months that you can feel comfortable with and do no more. I say to do no more because emergency fund money must live in a safe place. Therefore this money will most likely not be earning high interest or return in the stock market.

Minimum monthly expenses are things that you simply could not function without. Examples would be food, water, your home, transportation, and possibly insurance (health, life, and disability). In my emergency plan, I decided that I would cut all extraneous expenses such as cable, cell phones, subscriptions, eating out, etc. Take a look at your monthly expenses, cut out everything that you could live without and the rest add up to your minimum monthly expense. Then multiply this times the number of months you decided you need and you have your emergency fund balance.

A simple Emergency Fund Calculator

What are the benefits?

The main benefit of having a fully funded emergency fund is security. Your emergency fund takes away all worry about something bad happening. You will cover it. Nothing else in my financial plan has provided me with more freedom from worry than my emergency fund. It feels extremely good to log in to my account and see those funds sitting there ready to be called upon.

Another benefit is that it teaches patience and a sense of how to save. To be honest saving even three months expenses is challenging. It takes a long time. It is also challenging to have to look at all that money going into a safe place just to sit there and stare back at you. Do not let it break you. Once you have it fully funded, you will look back and know it was worth the wait.

Where Should You Put Your Emergency Fund?

If you listen to all the financial advisers, they will give options for where to put your emergency fund. There are only two qualifications you need to meet. The money must reside in a safe place and not exposed to risk of loss. Second, you must maintain access to the money. The ability to get access within 1 to 3 days is acceptable. Those are the only requirements. If you find a savings account that pays 6% interest, then first off, tell me where. Second off you have ridiculous luck. Savings rates these days do not even pay the taxes on the interest you earn. What does this mean? Do not think of your emergency fund as an investment in terms of return. Think of it as an investment in your well-being.

If you have any questions or want further explanation, comment and let me know.

About Kevin Jones

I am the owner of KJW3, LLC and the producer of Free Zero Based Budgeting. I enjoy learning and spreading knowledge about personal finances and zero based budgeting. Please enjoy our blog and zero based budget tool.
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