Law #2: Build and Maintain an Emergency Fund Like Your Sanity Depends On It—It Does
The Law
Indeed your sanity may depend on how well you prepare for an emergency. Emergencies happen. Unforeseen medical expenses, home appliance repair, car fixes, temporary unemployment, or short cash flow for new business owners. Either we are ready for the parts we can be prepared for to focus on the difficulties we can’t control, or we are miserably unprepared, and emergencies feel like a double burden. Those who weather the storm well don't necessarily have fewer storms; they prepare better for the storms that we all face in life. Your emergency fund allows you to implement an effective solution to resolve the emergency without stressing over how to solve it. Instead, all of your energy can go into effective implementation instead of scrounging up resources or borrowing money at terrible interest rates or from the wrong types of people. Your peace of mind in an emergency is what allows you to live fearlessly. Don’t live life without one.
Your Keys to Power
Your options for an emergency fund fall into 3 categories:
Options for how much to target
Options for building the fund
Options for where you stash your fund
How much to target for your fund. You have options on how much you target putting into your fund regardless of where you’re starting.
Rockstar. We recommend an emergency fund of 6+ times your monthly expenses for most. Six months of funds will allow you to weather almost any kind of storm and particularly unexpected unemployment. With 6 months of expenses stashed away, you’ll have time to look for new employment in most economic markets without significant stress and without having to settle for a job that you wouldn’t otherwise take.
Average. Having 3 times your monthly expenses in an emergency fund is what we’d like to see as a minimum to help you make it through most emergencies. While you may find it more challenging to navigate temporary unemployment, you’ll be able to handle the bulk of emergencies that come your way, like car trouble, most medical expenses, and home appliance repair.
Starter savings. If you’re struggling to see how you’d arrive at even one month of expenses in an emergency fund, or if you’re thinking, “I’ve never even had $1,000 in my account at one time,” start there. Target building up to $1,000 and chip away at it however you can. Even $500 will get you through some common emergencies, so start and don't stop.
A note about circumstances that may require more than 6 months of expenses. How much each person needs depends on your comfort level and how you make money. If you’re a freelancer, your business or work is seasonal, or if your job is tough to replace (i.e., if you’re in a specific niche that few companies need), you might need a larger fund of 9 to even 12 months.
A note about debt. If you've racked up a lot of debt, you may need to save some toward an initial emergency fund first, clear high-interest debt second, and then return to building a larger fund. If your job is secure and you don’t have any relevant worries about your employment, work toward at least $1,000 of savings while paying the minimum on your credit cards, then go in heavily on your high-interest credit card debt. If your job is not secure, focus on a higher emergency fund of 3-6 months while paying at least your credit card minimums before directing more of your funds to pay off credit card debt. We know there is competing advice about how and when to tackle credit card debt. Some suggest paying credit card minimums for as long as it takes to build an 8-month fund and fund your retirement. We believe, however, that tackling credit card debt is so essential to your financial health that we place it at a slightly higher priority, particularly if you’re younger than 50. Indeed, some of the advanced financial moves you can make to boost your financial growth require you to have debt under control and off your credit report, and we want you ready for those types of opportunities.
How to build your fund. There are two strategic options for building an emergency fund, and we encourage you to think about both depending on your fund target and how much you earn.
Save through expense management or cutting costs. What probably comes first to mind is saving from your existing earnings. Saving is a fantastic way to arrive at your emergency fund target, particularly if you earn more than you usually spend. It is important to understand your essential expenses and find ways to cut them back if you're spending almost everything you earn each pay period.
Save by earning more. Another equally viable method of building your emergency fund is to make more through your primary source of income like employment or a side hustle. If your expenses come close to meeting your take-home pay and you've cut every cost you can, you may need to consider finding ways to make more money. That may include asking for a raise and being able to justify that raise to your boss, asking for overtime opportunities, paying yourself more if you're self-employed and your business can afford that, or working a side hustle.
Where to keep your fund. Depending on how large your emergency fund will grow, you have a wide range of options for where you place your fund.
High-yield savings account. A high-yield savings account pays higher interest than a traditional savings account. Check out these online banks that have this kind of account. Check the interest rate the account pays and the fees the bank charges when looking at an online savings account. Also, check out any rules concerning withdrawals. Be careful with these types of accounts—they don’t come with a debit card or check-writing capability, and you’ll need to transfer funds from this account into a checking account to spend. Still, the higher interest rate and lower accessibility may help you earn more and treat the fund as a true emergency fund.
Money market account. Like a high-yield savings account, a money market account will earn a higher annual percentage yield than traditional bank accounts. But a money market account sometimes offers a debit card and check-writing capabilities, making them more convenient to access in an emergency. Another notable difference is that a money market account will generally require a larger initial deposit to establish an account, so check with your bank first to see how much they require to open an account to see if this is an option for you. Also, compare these options for a money market account to your current bank's offerings. Note that federal regulation limits the number of times you can transact from this account, but that shouldn’t matter—it’s an emergency fund!
Traditional bank account. If you can’t yet stomach holding your money in an online account or having it tied up for a day or two transferring it from a high-yield savings account into a regular bank account, you can always start by keeping your emergency fund in a traditional checking or savings account. You won’t earn as much interest, but you’ll have peace of mind knowing you can access your funds anytime. If you don’t yet have a bank account at an accessible brick-and-mortar bank, check out these top reasons you need to fix that fast. Our concern with keeping your emergency fund in a traditional bank account is the extreme accessibility of the money. If you’d be tempted to withdraw cash for non-emergencies, combat this by opening an account at a different bank from your primary checking and savings accounts and putting the money there to make it more difficult and hopefully less tempting.
Options for more significant funds. Other options include a Certificate of Deposit Ladder or a Roth Individual Retirement Account, but we aren’t focusing on these yet. If you’re already over $10,000, and your fund is continuing to grow handsomely, go ahead and ask a financial expert about these options. As our money topics become more advanced, we’ll return to those potentially higher interest-earning accounts. But for now, focus on what is immediately in front of you and easy to establish.
Practical Application
Figure out how much you plan to target. Use our Emergency Fund Wizard [scroll to the top or down to the bottom for the free tool] to help you figure out your initial fund target just by answering a few quick questions online.
Automate your emergency savings monthly. Turn your savings contribution into an automatic transfer after your payroll deposits if your earnings are flat. If your employer offers direct deposit, ask them about dividing your paycheck deposits between two accounts to make this process even more efficient.
Earn your way to a higher fund. There is no shame in a good side hustle. Here are 109 ideas for side hustles to get your creative juices flowing. You have the flexibility to work a side hustle just long enough to build your fund or to keep doing it for as long as you feel like it.
Round up your purchases to the next whole dollar to effortlessly save the spare change. If you need some help getting started, check out these savings apps that link to your checking and spending accounts, round up purchases (think a $2.75 purchase rounds up to $3.00), and automatically transfer the change to a savings account (i.e., $0.25 in this case).
Plan to save your tax refund. If you earn income through a job that gives you a W-2 (instead of 1099), your job is withholding taxes and paying them to the state and federal governments each payroll period. In some cases, you’ll receive a tax refund. Commit to saving this full tax refund and get out of the habit of spending whatever you receive.
Save money where you are most comfortable starting. Don't keep your money in an online bank if that's uncomfortable for you as you start your emergency fund. On the other hand, if saving your money in an account that is more difficult to access or that is further removed from your primary checking account makes it easier for you, do it. When you’re getting started, the game is all about doing what makes you perform well.
Go through your expenses regularly and cut the fat. When cutting back your costs, sharpen your razor and dig in. Review your expenses at least every 3 months, or more often if you need to, to ensure that you haven’t fallen into a subscription loop. Cancel unnecessary subscriptions right away and ask for refunds if something accidentally went past a free trial.
Authority
“Money looks better in the bank account than on your feet.” - Sophia Amoruso
“It is never too early to encourage long-term savings.” - Ron Lewis
“By definition, saving – for anything – requires us to not get things now so that we can get bigger ones later.” - Jean Chatzky
“Beware of little expenses; a small leak will sink a great ship.” - Benjamin Franklin
“Someone’s sitting in the shade today because someone planted a tree a long time ago.” - Warren Buffett
“Stop buying things you don’t need, to impress people you don’t even like.” - Suze Orman
“Don’t tell me what you value, show me your budget, and I’ll tell you what you value.” - Joe Biden
Money doesn’t make you immune to the little speed bumps in life, but it can easily turn an emergency into an inconvenience. - Dave Ramsey
Being the highly trained investment mogul that I am, I could certainly find places to put that money where it would earn more. Or would it? Remember, personal finance is personal. I have come to realize that Sharon's [his partner’s] peace of mind bought with the oversized emergency fund is a great return on investment. - Dave Ramsey
Save what you can toward the emergency and life happens fund. But don't worry yourself sick at the slow growth. The point is it's growing even it's just one dollar at at time. - Michelle Singletary
If the only way you can build an emergency fund is to pay the minimum due on your credit card, that is what you need to do. - Suze Orman
Do you have an emergency fund? If not, build one - aim for three months of expenses to start, then boost it to six. It will ease your anxiety and get you out of a potential jam. - Jean Chatzky
Our Vote
I’m a saver, and I believe in indulgent saving. It doesn’t mean I don’t enjoy spending and living well. It just means that if I’m going to spend as much as I do, I’m going to save even more. I started with a target of 3 months of emergency expenses, grew that to 6 months, and then grew it to 12 months. I targeted a higher amount for emergency savings because I live in Los Angeles, which ranked the 3rd most expensive place to live in the US for 2021-2022. After reaching 12 months of an emergency expense fund, I didn’t stop saving. Instead, I just directed those additional funds toward retirement and investment accounts, which I’ll share more about in the future.
Reversal
There is no reversal to this law for anyone not currently living in poverty. A multiple-thousand-dollar emergency fund is highly out of reach for anyone living in poverty and struggling to put food on the table. Your immediate needs may be much more basic, like food and shelter, and in that case, your focus must be on these immediate needs. Outside of impoverished conditions, you must focus energy on building an adequate emergency fund to keep your train on the rails of life when things get complicated.