What is an emergency fund?

Ouch. You find yourself in urgent care with an ankle sprain. Turns out it wasn’t that nasty after all, but now it’s time to pay up. Your medical insurance only kicks in after a deductible. That means you’re on the hook for $400 of the treatment. And that’s coming out of your pocket. Could you pay it without feeling a sting?

For many people, the answer to that is sadly, no.

A recent study by YouGov for the Economic Security Project found that 49% of all Americans don’t have an extra $400 in checking or savings to cover an emergency expense. That can mean medical expenses, car expenses, pet expenses, and so on.

Now, think what that could mean for an even bigger expense. Say you’re a bit shocked that you owe $1,200 on your income taxes. What then? Worse yet, what if you and half your team at work got laid off? Immediately, you’d find yourself scrambling for a job. Fast.

Yes, life’s bumps can shake you up. Some more than others. That’s where an emergency fund comes in.

So what exactly is that? How much should you have in an emergency fund? And where should you keep your money? We’ll cover all that here.

What’s an emergency fund?

An emergency fund is cash set aside for, well, an emergency.

It can cover plenty of things that life can throw at you, like that unexpected trip to urgent care. It can also cover things like your deductible if you’re in a car accident, a surprisingly steep income tax bill, or your living expenses if you find yourself between jobs.

You can think of an emergency fund as a safety net. It’s there for the unexpected expenses.

Why do you need an emergency fund?

Without an emergency fund, an unexpected bill can mean anywhere from financial heartburn to financial disaster. Depending on the size of the hit, it can take months or even years to recover.

What about covering that surprise expense with your credit card? Credit cards don’t cut it. First off, that runs up your balance and your minimum monthly payment. On top of that, you’ll pay 20% or so in interest every month until you knock out that balance. In a way, if you pay with your credit card, you end up paying for that unexpected bill again and again.

So, from a financial standpoint, an emergency fund is an absolute must.

Yet something else comes from having a well-stocked emergency fund – it feels good. You’re prepared. And if the unexpected does happen, you don’t have to stress about it.

Consider how relieved you’ll feel in these situations:

• Your company announces layoffs? You have a cushion while you find a new job. That means less stress and that you don’t have to take the first job that comes along.
• Maybe you need your car for work and the engine goes out. No worries. You can get it repaired and get back to work quickly.
• Your dog needs a procedure at the vet. You don’t have to think twice about it. You can take care of it right now.

How much should be in your emergency fund?

For most people, an emergency fund should cover between 3 to 6 months of expenses. That rule of thumb will vary, though. If a partner or someone else is providing some of the household income, you might need less in your emergency fund. If you’re responsible for a child, you might want to set aside more. The same goes if you work in a volatile industry or for a company with high turnover.

That’s not to say you need to put a hard cap on the number of months you save for. Some people have emergency funds that can cover a year of expenses. As for you, it all depends on where your emergency fund fits into the kind of life you want. For example, maybe you want to get out of town to clear your head after getting laid off. Extra emergency funds can help you do things like that.

Moreover, an emergency fund can do something else for you – it can earn you money.

Where should I keep my emergency fund?

First off, you want it saved in a place that’s safe. There’s no risk, and you can easily access anytime you need it.

But that doesn’t mean your money has to sit there waiting for something to happen. It can earn interest and make you money while you save for that proverbial rainy day.

You have a few options. You can open an interest-bearing savings account at your bank or credit union. However, traditional savings accounts typically have a low interest rate, which right now is floating just under 0.5%. Yet better, you can stash your emergency fund in what’s called a high-yield account (HYA).

An HYA turns your emergency fund into an extremely low-risk investment. It offers a higher interest rate than a traditional savings account while still giving you easy access to your money. For example, Facet’s HYA offers an interest rate of 4.40%. As for keeping that money safe, up to $250,000 of your money is insured by the FDIC (per individual). It’s also easy to set up.

For even more on why an HYA might be a great move for you, check out our article on compound interest and how it can supercharge your savings – and in this case, your emergency fund.

How can I build my emergency fund?

If you haven’t started building out your emergency fund, make it a priority. You can start with your next paycheck even if it's a small amount. Now, here’s a trick: set that money aside before you even see it.

Here’s what we mean by that:

•         If your employer offers direct deposit to more than one account, have a portion of your paycheck deposited into your emergency fund.
•         Set up an automatic monthly transfer from your regular account to your emergency fund account. Have it transferred on payday.

Both ways of saving follow a golden rule of personal finance … “pay yourself first.” And that’s meant quite literally. Your emergency fund gets priority because it prepares you for the unexpected and can earn some interest. It’s a great example of putting your financial wellness and your goals before spending on anything else. (Even if that means fewer movies and dinners out for a bit while you build your fund.)

Some of our members do something else to build up their emergency fund – they take on a  side hustle. That can look like a lot of things. Maybe you paint someone’s house, become a rideshare driver, deliver packages or food from time to time, sell on Etsy, or turn a hobby into a money-maker. The list goes on. No doubt, people get creative because that extra income can build a full emergency fund more quickly.

Then, just think of what you can do after you’ve built your emergency fund. Once you’ve built your emergency fund, you can take the money you would’ve paid into that fund and put it toward something else. Maybe that’s paying down debt. Maybe that’s starting a down payment fund for a home. Whatever you do, you can “pay yourself first” in some way that supports your goals.

And as always, we can help get you started. Your financial roadmap will include a recommended amount for an emergency fund and if an HYA is right for you. As always, you can reach out to your planning team with questions anytime. We’re here to help you build your emergency fund and give you a sense of relief when the unexpected happens.