Our society pressures us to spend, spend, spend at every opportunity, so it can be difficult to think about setting aside cash for a rainy day. Having an emergency fund that you can tap into during a time of financial hardship or uncertainty can help bring peace of mind. An emergency fund can act as a buffer when something unexpected comes up, allowing you to preserve your other investments.
What is an emergency fund?
An emergency fund is cash you set aside — either in a savings account or another liquid account —so that you don’t have to draw on your retirement accounts or sell other long-term investments when the timing is not ideal.
Emergency cash funds empower you to stay on your feet when the unexpected strikes, which can sometimes be expensive. You may find yourself needing to move across the country, facing expensive medical bills, or falling victim to a series of unforeseen and unfortunate financial circumstances. The ability to continue to support yourself and pay for food and shelter in these scenarios is no small feat.
Why is an emergency fund important?
An emergency fund can help cover you in the event that you find yourself in undesirable or unexpected circumstances. This might include:
- The loss of you or your spouse’s job
- Medical or health emergencies
- Major household repairs
- A long-distance move
- Major repairs after a car accident
- Unexpected but necessary travel
Without an emergency fund, you might be forced to dip into your IRA, 401(k), or other retirement savings, which can come with early withdrawal penalty taxes. Or, if you have money invested in stocks or ETFs, you may be forced to sell those at undesirable times in the market.
Finding the motivation to set cash aside in an emergency fund is essential. If you find yourself struggling to establish positive saving habits, consider making a list of some of the reasons to save listed above and post it on your refrigerator or your computer monitor as a friendly reminder.
How much should you have in an emergency fund?
The rule of thumb is that you should always have a minimum of three months of living expenses stored away in an emergency fund. If it costs you $2,500 each month to cover housing, food, and utilities, then you should have $7,500 in your emergency fund.
While three months is a solid target for individuals, those with financial dependents — like a child or a spouse — should aim for six months’ worth of living expenses in their emergency fund. Other considerations may factor into your unique situation as well. If you work in a field that has a high injury rate or high turnover, you may want to double the amount you have saved away.
Ideally, you should continue to save even after you’ve reached these benchmarks. Having 12 months of living expenses in a savings or other easy-to-access account can bring peace of mind that you’re ready for anything. Once you’ve reached this milestone, you may consider creating an “opportunity fund” that includes money set aside for investments.