FINANCIAL FRESHMAN #004
TL;DR → Emergency funds are critical to your financial stability, yet most Americans don’t have one. Experts like Vanguard suggest saving 3-6 months of your expenses. Store it in a High-Yield Savings Account to earn a competitive return while keeping your money accessible.
What is an Emergency Fund?
Life happens. You get a flat tire, your dog has an unexpected visit to the vet, you get a speeding ticket, or you break your phone and have to buy a replacement. You can think of your emergency fund as the cushion that you place between yourself and the impact of these costly, unexpected events.
Despite the simplicity of the concept, the average American is not financially prepared for an emergency. The most recent State of Personal Finance in America report from Ramsey Solutions highlights this truth with a number of eye-opening statistics:
- Only 49% of Americans have at least $1,000 in savings for emergencies.
- A whopping 33% of Americans have no savings at all.
- Almost half (48%) of Americans couldn’t cover their expenses for 90 days if they lost their income.
Building and maintaining an emergency fund is crucial for financial stability. In the next sections, we will explore how much you should aim to save as well as the best places to keep your fund.
So, How Much?
Let’s say that you graduate college and begin a full-time job as an accountant making $65,000 per year. Your twice-per-month paycheck lands around $1,950 after your withholdings, healthcare, and a 401(k) contribution. This means that $3,900 will hit your account on a monthly basis.
To derive an emergency fund amount from this figure, you must first know how much of this money is utilized to cover your expenses every month. If you follow a typical 50:30:20 budget (50% to needs, 30% to wants, and 20% to savings), we can assume that $1,950 per month is needed to cover your expenses. Financial institutions like Vanguard recommend that your emergency fund be able to safely cover 3 to 6 months of your expenses. This would put our emergency fund at $5,850 on the low end and $11,700 on the high end.
Be wary of any emergency fund advice that presents a static figure, as your lifestyle should always be taken into account. If you start a family and add $1,200 per month in childcare expenses, your emergency fund should increase accordingly. On the other hand, if you finish paying off a student loan and no longer have a $300 minimum monthly payment, your emergency fund can decrease if you’d like.
If you need to withdraw from your emergency fund in the future, prioritizing paying yourself back in the months thereafter is essential. Just because one emergency happens doesn’t mean that another one won’t follow soon after.
Where Do You Keep It?
Storing your emergency fund in the “correct” place isn’t something that you should lose sleep over. If the fund is able to be accessed quickly and without fees, you’re doing the right thing. However, it is possible to maintain accessibility while receiving an above-average return on your money. You could check both of these boxes by storing your fund in a HYSA, or High-Yield Savings Account.
In a HYSA, you could expect to earn up to 5.45% on your money, whereas a standard savings account would yield closer to 0.46%.
With our six-month emergency fund of $11,700, this simple choice of account is the difference between having $12,337.65 and $11,753.82 at the end of one year. That’s almost $600 more, just for parking your account in a different place!
Final Thoughts
Personal finance is personal. Your own comfort level and risk tolerance can, and should, influence how much money you have stored away for a rainy day. Either way, being told that you need to have a significant sum in an emergency fund can be demoralizing. Don’t be discouraged if you haven’t reached a fully-funded emergency fund just yet, habitually “paying yourself first” is what matters most.
Building this safety net takes time and persistence, but the peace of mind that comes from knowing you can handle unexpected expenses will be incredibly rewarding.
