Emergency Funds: How and Why You Should Get Started Right Now

Over and over again, I’ve referred to the value of an emergency fund without really explaining what it is and how you can get one. To put it simply, an emergency fund is the most valuable thing you can have because it protects you from the unforeseen things that can demolish all of your financial planning and throw you into debt.

What exactly is an emergency fund?
An emergency fund is a cash reserve that you keep in a safe place and use only for emergencies. This cash reserve should be as liquid as possible (a high-yield online savings account is just about perfect) and should contain at least $1,000 (at first) and eventually six to twelve months of your household’s take-home salary (eventually).

The only reason you ever tap into your emergency fund is if a situation arises that causes your monthly budget to not balance. Ideally, your monthly budget should have enough flex in it to handle things like a blown tire, but sometimes things happen like a dead transmission or a blown hot water heater and we simply need more cash than our budget can afford. This is when we turn to the emergency fund; it should have enough cash there to fix the emergency and then be replenished during the calmer times.

Sounds great, but I can’t afford one!
Can you spare $1 a day? Then you can get started with an emergency fund. With just $1 a day, you can have an emergency fund of almost $400 by the end of the year and thus reach the $1,000 mark in about two and a half years.

Most of us can skip a take-out meal or two, or maybe skip out on dining out or not go on a weekend spending spree, and come up with $10 a day. If you can do that, you can hit $1,000 by the middle of April and have almost four grand in the emergency fund by the end of the year. $4,000 can help out with many financial crises.

How I used an emergency fund: an example
I used to think this was overkill, but I started an emergency fund anyway at the insistence of many, many personal finance writers. I started slowly, putting roughly $7.50 a day into it. In three months, I had about $800 stored away.

What happened? The brakes died in my truck. It turned out that the brake pads on my truck were actually crumbling – it was not something I had expected to happen. The bill? $700. Normally, this would have made me utterly sick and kept me up at night, but since I’d cut down on my latte and sandwich intake (not even eliminating it, just cutting down), I was able to calmly write a check to cover the whole thing.

That night, I bumped my daily emergency fund imput up to about $20 a day, and it’s gone up from there. It’s a lot easier to give up your daily take-out and your silly shopping trips if you know you’re making yourself safe from such disasters – and you’ve actually seen it at work.

One other note: I also use my own emergency fund as the starting-off point for my investments. I contribute heavily to my emergency fund on a weekly basis and make sure that it stays above a certain level that I’m comfortable with. What do I do with the excess? I deposit it into other investments, such as my non-retirement mutual fund (which my wife and I are starting to call the “dream fund”).

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  1. Canadian says:

    Do you think you still need an emergency fund if you a) are car-free (so no unexpected car repairs), and b) live in a country with free universal health care (so no unexpected medical expenses), and c) would qualify for unemployment insurance if you were to lose your job? I do have money in savings that I could dip into if some emergency arose, but right now I can’t even think of an emergency that could happen (because of a,b,c above).

  2. Canadian says:

    Oh, and also d) don’t own a house yet (so no unexpected furnace problems or whatever).

  3. Trent Trent says:

    I would carry at least some small emergency fund. There are lots of things that can go wrong that could destroy your budget: your rental property is damaged, you have an unexpected child, or so forth.

  4. kozel says:

    I live in a country w/ universal health care, unemployment insurance and am car-free but you gotta have an emergency fund. I don’t want to count on the state to take care of me financially. Even if you do lose your job and get unemployment benefits, they benefits will generally not be equivalent to your salary, having some extra money on hand is always needed.

  5. conorm says:

    I would like to echo Trent’s point that cutbacks on frivolous daily expenditures can really add-up

    Last February I started an emergency fund with $25 dollars a week deposited into an ING Account. At the time I thought this was all I could afford (my salary hasn’t gone up since then), but I quickly got into the habit of depositing any spare cash whenever I could.I now have over $4k saved, and hoping to hit $8k by year end.

    I think its also worth nothing that the convenience of online savings accounts make this much less painful to achieve. I’d rather go to a leper colony than go down to the local bank and stand in line….

  6. networthington says:

    Ditto, conorm. I use the same online bank and have saved over 5 k so far. I just got a new job making twice as much as I was before, with bennies, etc., and since I am used to living on next to nothing and have no major purchases to pay off outside of school loans, I just push everything I can into savings. I know what it’s like to have to write a check to the mechanic when it’s the last $300 you have to your name, and believe me, making sure I don’t have to worry like that is worth the sacrifice of a starbucks coffee today.

  7. Aussie says:

    My emergency fund saved us when I decided to take a small break from working. We had enough to live on for 5 months. Now I am back at work full time, my husband also started work (he recently finished graduate school) and our emergency fund is being built up again.

    I love the ING savings account – better rates and very user friendly! Highly recommended.

    I am new to this blog and am loving it already!

  8. Tyler Norwood says:

    This is an excellent blog, Trent. I have read just about every article you have written in the past two weeks and loved every one of them.

    I have even started my own blog – albeit nothing to do with personal finance – and I think I owe the inspiration for it to you.

    Thanks then and keep up the good work.

  9. theobromacrunch says:

    thank you very much for this article. i started ING last 2005 with $25.00 every 2 weeks and whenever i had extra money whether tax refund or a referral bonus i add those to my emergency fund. so far i’m geeting good interests and it became helpful when i had a crisis recently. i’m planning to have a car fund so whatever amount i saved on that will go to car maintenance and hopefully a downpayment to a new car in case i need to get a new one.

  10. Toaduni44 says:

    If you want to open an ING Savings account, send an email to toddboruff AT yahoo DOT com and I’ll send you a referral link. You get $25 when you deposit $250 or more, and I get $10. What a deal!

  11. Matt says:

    ING is a pretty good high yield savings account, and very user friendly. However etrade.com also has a high yield savings account and their rate generally beats ING’s. Their site is not quite as easy to use but by no means difficult.

  12. Dan says:

    I think Trent is costing himself a good deal of money having an emergency fund. I’ll explain how.

    He has a 3% taxable return on his emergency fund right now (based on the ING ad to my right). However, his student loan has an 8% rate. He would be better off putting the $20 a day into that loan and setting up a $20,000 line of credit, which he could use in case of emergency. The line of credit won’t cost anything unless he uses it and he’d have the benefit of an 8% tax-free return instead of a 3% taxable one.

  13. Jorge says:

    Dan makes an interesting point about the line of credit above. The only issue these days is that banks are freezing lines of credit. So, if you get laid off and need to access it, it may not be available!

    The Wall Street Journal recently recommended some potentially controversial advice, to borrow on your credit card or HELOC and put it in the bank. That way you know it will be there if you need it. Check out my thoughts on this here:

    http://independentminded.org/2009/03/13/how-to-build-your-emergency-fund-fast/

    Enjoy!

  14. Outdoorseaguy says:

    The emergency fund. The best financial advice I’ve ever read (that and spend less than you earn). I’m in the middle of a financial emergency right now and I’m not sweating it because of the emergency fund. I’ll likely use 3/4 of it to pay this veterinary bill but that’s what it’s here for. It means I don’t have to use my credit card or ask my parents for money.

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