The average American Household doesn’t prioritize saving, let alone have money set aside for emergencies. Typically, most people do not have enough to cover an emergency that costs $500, let alone a more expensive one. In most households, dealing with an emergency involves going into debt. We’ll talk about this in the next post, but right now, let’s focus on what an emergency fund is.

An emergency fund is money set aside for unexpected emergencies. This should not include things like routine vehicle maintenance, preventative healthcare, gifts, vacations, a new phone, or anything else that you can plan ahead for. That’s what a rolling fund (or sinking fund), is for.

A true emergency is something completely unexpected that costs more than what you have available in your budget for expenses.

Some examples might be loss of income due to illness or the loss of a job, unexpected medical expenses due to an illness or accident, unexpected car repairs (not related to routine maintenance), or any number of other unexpected things.

Note, the key word is “unexpected”. If you know it’s going to happen at some point, you need to plan ahead by putting money aside for it in your rolling funds.

Everyone has to deal with unexpected expenses at some point. It’s not a matter of if, it’s a matter of when, and if you don’t plan for this, you are gambling with your financial health.

How much should you save?

The amount you need to save for your emergency fund will be based on your personal needs and preferences. It’s recommended that you have 3 to 6 months worth of expenses set aside in this fund. Notice, I said 3 to 6 months worth of expenses, not income.

To get this number you need to look at your monthly budget and determine what your necessary expenses are. In the event of an emergency, what items are necessary and need to be taken care of whether you are working or not? Some examples of necessary expenses might be:

• Shelter
• Utilities
• Phone
• Transportation costs
• Food
• Insurance
• Debt payments

These are a few basics you might consider but there may be other things in your budget that would need to be taken care of in the event of an emergency. Figure out the total of your bare minimum expenses for 1 month and multiply that number by 3 or 6.

If you live in a 2 income household, 3 months of expenses might be sufficient, but if you’re single or a 1 income household, you need to have 6 months of expenses set aside.

Building your emergency fund

3 months worth of expenses can seem like a dauntingly large number. 6 months, even more so. If this goal seems overwhelming to you, remember, you eat an elephant one bite at a time.

Any time you have a big goal, you can make it seem much more attainable if you break it down into a series of smaller ones. These are easier to achieve and will help you gain momentum as you go.

Start with a goal of 1 month of expenses. That number won’t seem so impossible and is much easier to have faith in. If you need to, break it down even more. Reach for 1 week. That’s just a quarter of your monthly essentials.

When you reach your first goal, you will feel a sense of accomplishment. Immediately start working towards the next one. Each time you reach one of these milestones, you will be more confident that you can do this.

When I started working towards the goal of an emergency fund, it did seem overwhelming. It felt like there was no way I could manage to save that much money. So I started with a goal of $100. When I reached that goal I raised it to $500, then $1,000. Next, the goal became 1 month of expenses, then 2, then 3, and so on.

With each goal reached, I celebrated with something small, like a new book, or treating myself to gelato. Nothing expensive, because I didn’t want to take the focus off saving, but something to congratulate myself. At some point, I no longer needed to reward myself with a treat because looking at that number grown in my account was more than satisfying enough and the peace of mind and sense of security I was gaining was worth every sacrifice I made.

Where should you keep it?

For the bulk of your emergency fund, I do not recommend keeping it in your regular savings account. You should keep some of it there in case you have a smaller emergency that requires immediate access to the funds. It’s up to you to determine how much this should be. I keep $1000 in my regular savings account.

The rest of it should be somewhere you can access it if you need it, but not so easy to access that you can instantly transfer it to your checking or get from an ATM. This makes it too tempting to spend it on something that isn’t really an emergency.

I recommend keeping the majority of your emergency fund in an online high yield savings account. You still have access to the funds if you need them, but since it generally takes a few days to transfer to your bank, you’re less likely to be tempted to spend it on a non-emergency.

Another reason for this is that, typically, the interest you earn in your bank savings is next to nothing. The bank offers a 0.3% annual interest rate. That’s a fraction of a percent, not even a whole one. What that looks like is this: If I keep $1,000 in that account for an entire year, I can expect to earn a whopping total of $3 in interest. That’s not even worth blinking at.

On the other hand, if I put that same $1000 in a high yield savings account that earns 4.5% interest, I can expect to earn a total of $45 in interest over the course of a year. Still not a lot, but much better than $3. Plus, the value of your money is better protected from inflation this way.

Summary

• Decide how much you need to save based on 3 to 6 months worth of necessary expenses.
• Achieve this through a series of smaller savings goals so you don’t get overwhelmed.
• Keep a small amount in your regular savings account for immediate expenses if needed.
• Keep the rest in an online, high yield savings account.
• Don’t use your emergency fund for anything other than actual, unexpected emergencies.

When you do have an emergency, you’ll have peace of mind knowing you are able to handle it without struggling. And if you do have to use it, put the money back as soon as you can. Put a pause on your other savings goals until you have it built back up, then resume your plans.

Building your emergency fund is not easy, but it’s also not impossible. And the benefits will always outweigh any sacrifices you have to make in the process. You’ll be glad you did.