What an Emergency Fund and Why do you Need one?

If you’ve read anything on personal finance, chances are you’ve heard the advice on creating an emergency fund. If you haven’t researched much, that’s OK too – I suggest starting with my step-by-step guide.

So what is an emergency fund?

An emergency fund is where you keep money that you could easily take out (liquid) should an emergency arise.  The example I always use is a car break-down. I love my baby, but she is 10 years old. A catastrophic break down is not out of the realm of possibility. I need to be able to pay for a large repair or even a down payment on a new car should the worst happen. Other examples of emergency fund uses are unexpected medical issues (trips to the emergency room are not cheap), replacing electronics that die unexpectedly, or immediate home repairs.

How much do I need in my emergency fund?

There’s not a one-number fits all here. Usually the suggestion is 3-6 months living expenses. The idea behind measuring it in month expenses rather than “new car expenses” is that if you lost your job, you want to be able to still pay rent and eat without going in to debt. The exact number can change depending on a few factors:

• If your income is not steady, such as freelancing, consider 6-9 months expenses

• Your expenses vary widely from month to month, stay closer to 6 months

• If it will take you a long time to find a new job in your field, stay closer to 6-9 months

For example, if you’re young and able to move back in with your parents relatively easily should you lose your job, you’re probably ok with a smaller emergency fund than a single provider for a family of 4.

Where do I keep my emergency fund?

This is one of my favorite questions because I love talking about online banks. I keep my emergency fund in a online bank, Synchrony. I have a few reasons I don’t just keep it floating in my checking account:

• Synchrony earns 1.05% (varies) interest. That’s 105x more than my checking account is currently earning. With $6,000 in there, I earn $63 dollars a year vs. $0.63. That might not sound like a lot, but that’s a free nice dinner or new pair of work pants for doing nothing!

• It’s separate from my primary checking. It’s mentally have this account walled off. I know if I saw an extra $6,000 sitting in my account every time I went to pay my credit card, I’d be tempted to splurge more often.

• I don’t need it instantly.  If I were to have an emergency, I have a large enough credit limit that I could charge it to my credit card and pay myself back after the few days it takes to transfer from my online savings to my primary checking. Also, I have the privilege of having my parents close and in a position they could help me out should shit really hit the fan.

If for some reason you think you might need your emergency fund available from the ATM, consider opening a second account at your primary bank (Chase, for example). You won’t earn the great interest rate of a online savings account, but the peace of mind of having it available the second you need it might be worth the extra $50-100 a year to you.

Can I keep my emergency fund in a brokerage account? 

I don’t recommend this. The point of an emergency fund is not to make money (despite how excited I get about the extra $63). It’s there so if something unexpected came up, you could afford to ride it out without going into financial ruin. Funds invested in the market can fluctuate a lot. If you put in $5,000 and then the market declined 20%, now you only have $4,000. If you needed $5,000 now you have to come up with that extra $1,000. Not to mention the fees associated with a brokerage account.

The only way I could see this working is if you left your money in a money-market account. money market accounts make about 0.5% so if you were really set on keeping your emergency fund in a brokerage account I would make sure to keep it in a money market fund.