Emergency Funds Explained: How Much Cash Should You Actually Keep?

 

An Emergency Fund Is Protection

An emergency fund isn't an investment and it definitely isn't money you're saving for something you want. It's money set aside specifically for unexpected expenses or a sudden loss of income. Some people make the mistake of having the fund be a backup for any extra expense. The goal isn't to make the money grow as quickly as possible; it's to make sure one bad month doesn't completely derail your finances. Essentially, the fund is a safety net in case any real emergency happens, but what actually cous as an emergency?

Trust me, not every unexpected purchase is an emergency. A broken laptop that you need for school could be one, while wanting a new phone because yours is two years old absolutely isn't. Medical expenses, urgent car repairs, unexpected travel for a family situation, or losing a source of income are better examples. I would consider making a quick list of some of your specific emergencies, so you know exactly what to expect. 

I find that many people wonder, "why can't I just pull money out of my investments?"It might seem unnecessary to keep cash sitting around when you could invest it instead. But investments can fall in value, sometimes at exactly the moment you need the money. If your emergency happens during a market downturn, you could be put in a bad situation, and forced to sell an investment for less than you paid for it. This is the main reason why you should strongly consider having a good emergency fund, perhaps even before you start investing. 

There's no universal emergency-fund number that works for everyone. Someone with a steady job and very few expenses may need way less cash than someone supporting a family with a mortgage and several monthly bills. A common starting point for adults is several months of essential expenses, but teenagers and young adults often have much lower financial responsibilities. The point is, if you have bills to pay or monthly expenses, have 3-6 months worth of those expenses in your emergency fund. Just imagine you lose your job for a few months, but you still have bills to pay. This is exactly where the fund will prove useful. 

Your Emergency Fund Should Match Your Life

A teenager living at home probably doesn't need the same emergency fund as a 30-year-old paying rent, insurance, and a car payment. If your parents cover most major expenses, your emergency fund might initially be designed around smaller personal emergencies. As your financial responsibilities increase, the amount you need should increase with them. 

Now, where exactly should you keep this emergency fund? Well, an emergency fund needs to have two main things, at least in my opinion, and that is to be safe and accessible. That generally means keeping it somewhere like a bank savings account rather than putting it into stocks or other investments that can fluctuate and are volitile in value. A high-yield savings account can potentially allow your cash to earn interest while remaining relatively accessible. The key thing to keep in mind here is that you need to be able to reach the money when the emergency happens, not have to wait to take it out of some longer term investment. Let's just say you shouldn't really be focused on the returns your emergency fund has. 

 Don't Let Your Emergency Fund Become Your Spending Account

One of the easiest ways to destroy an emergency fund is to treat it like extra spending money. If the money is sitting in the same account as your everyday purchases, it becomes much easier to convince yourself that you can afford something. Keeping it separate can create a psychological barrier between your emergency money and your normal spending. Just make the system simple enough, where you can't spend it on whatever you want. 

How to Build One When You Don't Make Much Money

Saving several months of expenses can sound impossible when you're only making a few hundred dollars a month. The solution isn't necessarily to save a massive amount immediately. Start with a small target, such as your first $250 or $500, and gradually build from there. A portion of every paycheck, side-hustle payment, or other earned income can go toward the fund until you reach your target. 

Using your emergency fund doesn't mean you failed at saving. That's exactly what the money is there for. If you have a legitimate emergency and need to spend some of it, the next step is simply to rebuild the balance afterward. Just slowly take some time after the emergency to rebuild the fund, and don't stress out about it too much. 

The Goal Is Financial Independence, Not a Perfect Number

There isn't a magical emergency-fund balance that suddenly makes someone financially secure. The purpose is to create enough breathing room that an unexpected expense doesn't force you into debt, sell investments at the wrong time, or completely disrupt your plans. As you get older and your responsibilities change, your emergency fund should change with you. Guys, just try to keep this advice, and you will be fine whenever that emergency occurs, and I promise it will eventually.