What Is an Emergency Fund?

You never know when a financial emergency will strike. For example, what if your car breaks down tomorrow? What if you need to fly home to see your sick grandmother? What if you lose your job? Although most Americans understand the importance of saving for retirement, many neglect to save for urgent crises. Then, when caught in a financial predicament, they are forced to go into debt or tap into their IRA or 401(k). For this reason, everyone should have a little money put away for a rainy day (i.e., an emergency fund). So what is an emergency fund and how does it work?

What Is an Emergency Fund?

An emergency fund is a sum of money saved for unexpected, serious situations that require immediate action. Although emergency funds vary in size, placement, and use, no one can deny their importance or practicality. Everyone needs an emergency fund. 

How much money should be in my emergency fund?

Most financial experts agree that your emergency fund should contain enough money to cover four to twelve months of living expenses (not luxuries). So if you lose your job, you will have several months to find another. The more you save, the greater your peace of mind will be. In addition, we encourage you to begin building an emergency fund before saving for retirement or paying off non-critical debt. After all, it will protect you in the here and now. As soon as you build a sizable emergency fund, you can put money toward your debts and your future.

Where should I store my emergency fund?

Financial institutions don't carry accounts labeled as emergency funds, so you will need to create a new account for the money. Some people simply keep the money in their regular savings account. If you choose this route, you must realize that you aren't allowed to touch the money until an emergency strikes. If (like many people) you can't trust yourself to do this, create a new (highly liquid) account for the savings. Common choices include regular savings accounts, certificates of deposit, and money market accounts.

When am I allowed to use my emergency fund?

Although you can decide for yourself when you're allowed to remove cash from your emergency fund, we urge you to be sensible and sparing with it. For example, most people consider the following situations worthy: job loss, medical expenses, critical pet care, car repairs, home repairs, tax and utility bills, and unanticipated travel (to see a sick relative, attend a funeral, etc). Never use your emergency fund for luxuries or anticipated expenses.

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So what is an emergency fund? It is your financial lifesaver in a sticky situation. Whether you're laid off, sent to the emergency room, or stranded on the side of the road, your emergency fund should cover the sudden expenses. Crisis averted!

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