What is an emergency fund? How much should I have in my emergency fund? Where should I keep it?
What is an emergency fund?
It is simply cash that you have available in an account in case of an emergency. Emergencies can range from a car breakdown, a trip to the ER, a water heater going out, or maybe a water line breaks in the yard. The new iPhone coming out or a new outfit at the store are under no circumstances an emergency. You may feel like they are an emergency but don’t confuse passion and desire with necessity and need.
How much should I have?
This number can vary, but most advisors and bloggers would make the case for 3-6 months income and I would not argue. I won’t argue with you if you want to have a year. I think you should really look at the next question if you are going to have that much available and maybe have a multi tiered approach. A survey from late 2015 found that over half (56%) of Americans had less than $1,000 in their checking and savings account combined. Nearly 25% have less than $100. That is crazy. No wonder so many people are so close to the edge of the cliff. Think about it: It is likely that half the people in the restaurant while you are eating out, if they lost their income tonight, they would not have enough money to last a week.
We have an emergency fund of about 3 months at this point. I am pretty comfortable but I could see us moving to 6 month eventually. We have other priorities to accomplish first. The amount you have should be based on your comfort level. If you have never had an emergency fund, $1,000 would make you really comfortable. Job stability, comfort level, expenses, proximity for family support are all things that you should consider when determining how much you should have.
Where should you keep it?
An emergency fund is not an investment. It is a safeguard from disaster. Looking to maximize returns on this money is not the goal. We keep our money in a couple different places and I will explain why we do.
- Our checking account– We keep more than a month worth of money in our checking account. This means that unless something crazy happens we now have the money in checking to make all our budgeted purchases all month. No worrying if we can pay that bill before our next paycheck. (we could pay them all on the 1st if we wanted).
- HSA– We have about a month of expenses in our HSA. This is only for medical expenses but for us this makes sense. We have five very active kids and this provides safety if there is an injury.
- Savings/Roth IRA– We keep just over a month of expenses in our Roth not invested in the stock market. I know people will scream about never taking money out of retirement but hear me out. We are not to point of maxxing out a Roth every year. This provides us extra retirement saving while still providing security. I will go into much more detail on this eventually but 2 quick points.
- Why does this work? All contributions to a Roth IRA are made after-tax. You were already taxed on this money and you will not be taxed if you withdraw it. Again you can withdraw contributions only without penalty or tax.
- This is our 3rd line of defense. I hope that the money that is there is there for good. I hope that I never have to take it out and in time I can invest it more aggressively. It is already there so any interest or earnings are tax free.
We are in the process of moving our accounts to Fidelity. They offer a checking account, Roth IRA, an HSA, and tons more. I like the ability to transfer money within Fidelity in a single day and I am not tempted by seeing a larger balance in various accounts. I spend based on my YNAB categories. I also have no need to go into my personal bank in over 2 years. I am entirely comfortable with an online bank at this point. They also reimburse all ATM fees so if I need cash it won’t cost me anything to get it.
Are you part of the majority of Americans who have less than $1,000 in the bank? Or, you have a year worth of expenses in savings? Wherever you fall in between find a level you are comfortable with. If you are not comfortable with where you are, start saving. Skip eating out the entire month. How much could you save? I bet it is more than you think.
Comment in the notes what the goal is for your emergency fund.