What’s with the emergency fund?

Emergency funds are good. They’re great even. But how much should you put in yours? And where should it… live?

Not all emergency funds are created equal

Determining the right amount for an emergency fund can be tricky. First, you need to know your monthly expenses. This is a ballpark number, so it doesn’t have to be accurate to the dollar. As long as it’s honest enough to represent your realistic spending, that’s good. Add up the major recurring things like rent, phone bill, student loan payment, and car payment. Then add your average monthly debit and credit card spend, and you have your expenses for one month. Whew!

Then just multiply your monthly expenses by however many months you need to cover. Easy, right? Ummm…

But really, how much?

The math might be easy, but understanding the number of months to aim for is definitely the hard part. Experts recommend between 3 and 6 months, or maybe more. So, if you have $2,000 of living expenses, you need $6,000. Or $12,000. Or more? Gulp.

The right number varies from person to person, and that’s OKAY. Consider what you might do if something happened—an actual emergency. What if you lost your job and you needed money? Can you call Mom and Dad? Can you ask your roommates to cover your rent for a month until you figure something out? What about for two months? Or maybe you have that rich uncle everyone’s always looking for…

Think about how hard it would be to find a way to pay for necessities in a tough situation. If you have a pretty good idea how you would get help, it’s wise to keep this number smaller, 3 or 4 months, or $6,000-$8,000 in the example above. After that, use any additional money to pay down debt or invest for the future. Carrying a huge balance in a savings account might prevent you from doing those (also important!) things.

If you’re really not sure what you would do, or if you have other people depending on you, you might want to plan for 5 or 6 months of expenses, more like $10,000-$12,000 in this example. Paying down debt and saving for the future are just as important, so make a plan to dedicate money there after you’re set up with your emergency fund.

Where to stash your cash

Most experts recommend an emergency fund should be in a high-yield savings account. That means you can earn a little bit of interest on it, unlike most checking accounts, but you can’t lose money, unlike brokerage accounts.

The thing to remember here is that you’re saving, not investing. There’s a difference. Saving is something you do today, in case you need the money pretty soon. It’s a back-up plan in case of emergency (ICE). You want to make sure the money you might need tomorrow is money you can’t lose.

Investing, on the other hand, is a long-term game. You might lose a little from month to month, but over time (10, 20, 30 years), the risk decreases and the earnings are much, much higher. This is why people invest their retirement money in 401(k)s and other accounts, instead of just saving it.

What about my checking account?

You need money there too, obviously. Keep that to 1-2 months of expenses, enough to pay rent and necessities without having to move money back and forth between accounts. Most banks have pretty good tools to help manage this.

What not to do

Don’t touch it! Really ever. That’s the idea at least. Set the money aside forever and then just feel good about having that back-up plan. In other words, put it on ICE 🧊 and then “let it go!” 🤣 (Dad jokes, Disney edition)

You need a new car? Don’t touch it. Plane ticket? Don’t touch it. New shoes? Borrow small if you have to, and then pay the money back to your fund as soon as you can. It’s a good habit to get into.

-----

Once when I was in college I had $37 in my bank account. I had a part-time job but wasn’t getting paid for another week, so that’s all that was in there. I mentioned this to my mother on the phone, thinking it a trivial anecdote of my fun and frivolous (and yes, privileged) college life. She gasped in horror. “What if something happened?” She insisted on sending me money, and my first emergency fund was born.

I was passing calculus, but had no appreciation for how close 37 dollars is to zero dollars. My mom also has a particular way of saying a particular word. That word is “dumb.”