As all of you see every day, catastrophes happen. An emergency fund is the financial buffer between you and an unexpected $10k bill for home repairs, car trouble, or other expenses. This post shows how much to set aside and where to keep it.
How Much to Save?
Add up all of your essential monthly expenses for housing, food, transportation, and debt payments. Don’t include stuff you don’t have to spend money on like vacations or dining out. For example, if this was your budget:
Then monthly essentials would equal $4,500. Now multiply that by three. That’s the minimum you need in an emergency fund. At the maximum stash away 6x monthly expenses. Anything beyond that is an excessive amount to be saved and not invested.
There’s not an exact formula for your emergency fund balance. For example, if you’re a dual income household who rents and drives reliable cars then you need less saved up than someone in a single income household that just bought a fixer-upper and drives a BMW.
Don’t use every extra dollar for paying down debt or investing. Needing $7k for a new roof without a safety net means you’re going to go deeper into debt. First get an emergency fund, then aggressively pay down debt and increase investment contributions.
Let’s say your emergency fund goal is $10k and you currently have $5k. Save $417 a month for the next year or $208 per month for the next two. This table shows what you’d need to save per month for different amounts:
Where To Keep It?
Keep your emergency fund separate from your checking account. If it’s commingled with your primary account then it becomes easy to use for routine expenses. Plus, most checking accounts don’t pay interest.
An emergency fund needs to be easy to access, have zero risk, and pay interest. For example, sometimes people put their emergency fund in a certificate of deposit. CDs do pay interest, but they’re not aligned with the purpose of the money. CDs are locked up for fixed time periods and typically have redemption penalties – not what you need in an emergency fund.
The best place for an emergency fund is an FDIC insured savings account at an online bank. Online banks tend to pay more interest since they have less overhead.
Ally, Marcus by Goldman Sachs, and American Express Personal Savings are three of the best places for your emergency fund. All three have zero fees, no minimum deposits, and consistently pay higher rates than local brick and mortar banks.
Emergency Fund Summary
- Why: Life happens and you need a financial safety net.
- How Much: Three to six months of essential expenses.
- Where: FDIC insured online bank separate from your main checking account.