Do You Need an Emergency Fund?

do you need an emergency fund?I used to think of an emergency fund as robbing myself. It was essentially the same as paying taxes in my mind. All I knew was that money was coming out of my pocket going somewhere else. Obviously, this was completely untrue, but it was how I felt at the time. Thankfully, I learned how beneficial an emergency fund is to my long-term financial well being.

If you had a $500 unexpected expense come up right now, how would you pay for it?

If you could come up with the money and NOT have to use a credit card, you are doing much better than most Americans. Life happens, and unexpected expenses are to be EXPECTED. If you prepare for them you will be able to better avoid a financial crisis, if not, that is what they call “learning the hard way.” Lets say (for sake of discussion) that emergencies happen, on average, once every year (everyone’s definition “emergency” is different, so the frequency may be more or less for you) and cost an average of $500. The truth is that just about everyone does have an emergency fund. The only difference is that they are either earning interest or paying interest.

Paying Interest

Let’s look at the typical American response to an emergency (costing our assumed average of $500). Emergency #1 happens and they don’t have an emergency fund, so they borrow the $500 from a credit card (17.5%). This solves the short term problem of paying for the emergency, but now they have to start making payments to the credit card company.

Things are tough enough, they didn’t have the money to pay for Emergency #1 to begin with, now they have to try to find $20 each month to pay the minimum payment and to add insult to your injury the credit card company is going to charge them a huge percentage rate on the amount borrowed. When emergency #2 happens they will likely be:

  1. Still trying to pay for Emergency #1 (they will still owe $350)
  2. They will still be paying the interest to the credit card for Emergency #1
  3. It is probable that they were not able to save up for emergency #2, since they were still spending extra money to pay for emergency #1, therefore they will have to borrow again to pay for Emergency #2
  4. Now they are paying back both Emergency #1 and #2 ($850 total), paying interest on both amounts borrowed, and in even a more difficult place to start saving for emergency #3 since their minimum payment increased to $35.

This is only the beginning of the vicious cycle: it only gets worse from here. You can imagine what their financial lives will look like in 5 or 10 years.

The prudent see danger and take refuge, but the simple keep going and suffer for it. -Proverbs 27:12 (NIV)

Earning Interest

Let’s assume you are one of the few (but extremely wise) Americans who decided to start an emergency fund (because some equally wise ;) blogger told you it was a good idea). If you were able to find that $50 a month now (before emergency #1 happens) and start saving it to prepare for it, you would likely (and hopefully) be here when emergency #1 happened:

  1. Have more than enough money saved for emergency #1 ($600 saved)
  2. Will have earned interest ($15) on your savings which will have just increased the size of your savings even more ($615)
  3. You will have a head-start saving for emergency #2, because you saved more than enough for emergency #1 ($615-$500=$115)
  4. You will be earning interest on what you still have saved after paying for emergency #1 ($115), and you will be saving and earning interest on the amount you are saving for emergency #2.

When emergency #2 rolls around you will have $735 saved up to pay for the $500 emergency. Just repeat the process again and again and you can imagine what this will look like after 5 or 10 years.

How much should I put in my emergency fund?

I think $50 a month is a good ballpark to get started for many people. Obviously if you are making six figures, you may want to increase the amount or if you are making four figures, that may be too much. If you are having trouble finding the extra money, you may need to quit spending everything you make or learn what to do with a raise.

Where do I start an emergency fund?

These days high yielding savings accounts have terrible interest rates. I still like and use ING Direct for my emergency fund, but the most important part is getting started, no matter where it is. But, look for something that you can direct deposit into so you do NOT have to think about it.

Before I get a bunch of comments arguing about the frequency of emergencies or how much the average emergency costs, let me just say these assumptions are based on how things have worked out for me. I am sure some will have “emergencies” every 6 months and some every 4 years, but I am basing this off averages in my life. My intention is only to show the long-term benefit of building an emergency fund rather than using a credit card.

Homework:

  1. Create an emergency fund
  2. Set up Direct Deposit for the account to automate it.

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39 Comments
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  1. Although I agree. In an actual emergency, I find it easier to pay for it with a credit card, and then withdraw the money from my emergency savings fund later. This is especially the case if I don’t know how much the emergency will cost in total before its over.

  2. Very well outlined. I just finished funding my emergency fund to $1000 last month. I have such a different outlook on my finances now! I was finally able to ditch the last credit card I was keeping around the house (for emergencies).

    And to someone who is just getting started- absolutely get started now. I started with $50. Just give it some time.

  3. Very good thoughts, and I agree totally with the cycle you get caught in without one. My husband and I have/are living that vicious cycle of emergency after emergency and still paying for it. I am in the process of establishing an emergency fund at ING, with $70 per month for the time being. If the good Lord willing and the creek don’t rise, I should have close to $2000 by this time next year.

  4. @plonkee

    I agree, IF you have enough discipline to pay it off each month, that is a good idea.

    @FinanceandFat
    Isn’t it a great feeling? I feel so liberated, just by having an emergency fund built up!

    @Michelle
    Awesome! That is good to hear and when you hit your goal, check out the post I mentioned at the top about making more money from your E-Fund – the method I used helped me build it a lot faster than I thought I could

  5. We funded our first emergency fund earlier this year, $1000. We threw everything we had into it and we were able to do it in about a month. Oddly enough since we’ve funded it we’ve had a few car emergencies come up but haven’t had to touch the emergency fund. Before having the emergency fund we would have just charged car repairs. (we are not charging anything anymore) but it is SUCH an awesome feeling knowing we have that money there in case something comes up.

  6. @Erin

    Way to go! You are right, it is such a good feeling to know that the money is sitting there just in case…

  7. I like the ING account for saving $ for an emergency fund, but when I had to take $ out it took forever. I am trying to establish a stash of cash for true emergencies. I guess it depends on what emergency you are planning for.

  8. Minimum Wage

    If you had a $500 unexpected expense come up right now, how would you pay for it?
    ——————————————

    I would have no way to pay it. What happens then?

  9. jeff alexander

    I recenty lost my dad this new year. And it coas all our money for bills. Loans and credit cards bills and everyday bills are butting me and my wife into a financial debt and behind on all debts we owe. I need a financial merrical!!! HELP!!!!! CONSERNED BROTHER IN THE LORD JESUS CHRIST

  10. @Jeff
    I am going to email you about this since it is a fairly personal matter…

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  14. Jennifer

    I love the idea of an emergency fund, but I have a quick question? Is it better to build an emergency fund or put the money towards debit reduction? I am getting an extra paycheck this month (I get one every six months) and I was wondering if it would be better to put it towards paying off a credit card or into my emergency fund. My current emergency fund has less then $100 in it (I just started building one), so I would like to get it built up. However, my interest on my credit card is going to be increasing in a few months so I would love to get it paid down. What are your thoughts?

    • Jennifer, I like Dave Ramsey’s approach. He suggests first building up a $1000 emergency fund and then start paying down the debts. The $1000 should provide a buffer for emergencies that will prevent you from having to use credit cards if the car breaks down or something similar

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  16. Hey Bob,
    We all need emergency funds. i support to David Ramsey approach of building up $1000 emergency fund and then start paying debts.

  17. excellent article, nice way to start, here in Pakistan financial situation is not much different from US but earning capacity is much different, I also start saving 5000 pak rupee = round 50 $. let see how much time i require to reach equal to 10000 $. But i successfully paid all my credit cards a just a few days back, this change happened after reading articles on Chirstianpf, i am by the way not christian but i believe that Jesus is for every one.

  18. Dear Bob et al:
    The other difference between having an Emergency Fund and not having one is the fallback position: If you spend $50 extra a month on debt, you may well pay off a few debts a little faster. But when (not “if”) an emergency happens, you will be forced to take out more debt in order to deal with the emergency. Ask an airline for a “bereavement” fare (sold on an “emergency” basis to people facing an unexpected funeral) and you’ll quickly discover the world’s lack of sympathy for you: They’ll actually charge you more for it! Same with emergencies. Most banks won’t give you an “emergency” loan on reasonable terms. Instead, they’ll offer a “personal” loan at a ridiculous interest rate. Credit cards, of course, are even worse. So you will always be better off with a buffer zone; banks know this. It’s why they offer “overdraft protection”. Difference between the emergency fund and the bank’s OP plan: A hefty percentage of interest and fees.

    I don’t charge myself interest and application fees on my emergency fund…which is why it’s a better idea to have one.!

  19. My first emergency fund had only 2-3 months of expenses. That was a number of years ago.

    Today, I’ve got one for 5 years worth of expenses plus a relocation budget, in-case I need to move for a new job.

    Also, I’m only buying real estate with the idea of using the place for retirement. I currently rent it out, seasonally, for vacationers. That’s covered the taxes and maintenance costs. Otherwise, I rent a cheap apartment so that I can be mobile for work. The mortgage on the property is 15 years.

    I believe that in the years ahead, those who can move easily for work, will be marketable. Granted, it would be nice to be near one’s hometown (or general place of roots) but that’s not the economy, looking ahead.

    Like many others, I don’t want to be a renter during retirement, however, during the active part of my career, it’s not a bad way to go, in terms of being able to move to where the jobs are at.

  20. Jeff Schwandt

    Working the budget with my wife has made a huge difference in how our money is handled. Not only are we benefiting from her wisdom, but I’m also learning how to communicate better with her. It was her wisdom that pushed us to set aside a Contingency fund for emergencies and to cover deductibles. The overall goal is about $15,000, with her help and the HSA at my job, we’re almost to 50% of that goal. It’s nice to know that you’re prepared.

  21. Cherylcat

    Establishing an emergency fund is the MOST important step anyone can take toward financial peace and control of money! Having CASH in an emergency fund means there’s money for unexpected expenses that sent you running to the credit cards before. We’ve built (and spent) our emergency fund THREE times; the 1st time we hit it I freaked out! But that’s what its there for. When we needed major car work, an unanticipated emergency with our out-of-state son, un-covered medical, the credit cards stayed in the drawer and we had money to pay for it. You find you can handle a financial sideswipe and begin to feel control, even power over your money, instead of it having power over you.

  22. The freedom you feel having $1,000 in savings, and the ability to cut up “all” of the credit cards is simply “incredible”. Positively, simply, incredible! I can’t even describe the weight that has been lifted off of our shoulders…

  23. One easy way I like to save money. Every time I purchase merchandise at any business In which I pay cash for, this is what I do, instead of giving the clerk change out of my pocket I always break another bill so I can keep all of the loose change in my pocket and when I get home I take all of the change and drop it into a jar of bucket. Often I will add a few paper bills such as a couple of dollar bills or maybe a bigger bill if I feel I can spare the extra money that day. Then when the container gets to a point it becoming full I take the change and bills to the bank and have it counted and deposited into my savings account. You would be amazed at how much has adds up over a years time. I would recommend not letting the amount of change get out of hand before cashing it in as it could be a problem. My bank does not charge me for running the change through their machine but some banks might object if the quantity of change is high. It is one easy way that I have found to help me save some money. I have done this for many years now and it has become second nature for me. Try it for yourself and I am sure you will be pleasantly surprised.

    • Victoria

      O’Neil this is great, and fun too! My emergency fund strategy is similar: I save all pennies and nickels in separate jars until full. I add to that all overtime pay and bonuses throughout the year. This is in addition to regular contributions. My goal is $3,000. (More than half way there). I only use for small emergencies right now — this way I’m able to pay it back faster. It is a GOD-SEND not having to take out loans or use credit cards. The best financial move I have ever made!

  24. Great post as always.

    I work at a bank, and see first hand how many people do and don’t have an emergency fund. It is scary how many people don’t, I would have to say about 50% of our customers are under funded in their emergency fund. Times are tough, and people just aren’t able to save as much as they use to. Saving just $50 a month is a great way to at least start building an emergency fund.

  25. Diane

    When we were raising our children [3 girls] my husband and I had emergency funds. He was active duty military [USAF], and we were always prepared. Those days have been passed [10 years] and now we find ourselves as grandparents to 7 grandchildren and it seems like our emergency funds keep getting “donated” to our grandkids, unfortuneatly things happen and then we get stuck. Anyone know how to differentiate so a grandparent can know where to draw the line? We’ve tried explaining to our kids that we already raised ours, and they need to do the same with theirs, but they get to a stumbling block, and the next thing we know, its on us.

  26. Thanks for the advice. However, I save some of my money (deducted every month ) with a co-operative society and they normally have an emergency loan facility one can utilize in cases of emergencies. The loans have very low interest rates as compared to other lenders hence affordable. I prefer to use them for development loans, school loans etc. for the same reason.

  27. Thanks!

  28. Good advice overall, but I think the $50 per month assumption is completely arbitrary, and not useful. I would challenge each person to identify the amount that is right for them, an amount that’s easy to do, but easy not to do. Commit to setting aside an amount that you consider to be simple and painless, but definitely start somewhere. Even $5 (or $1!) is better than nothing, because it puts you into a pattern of behavior that will be beneficial for you long-term. Once you’ve accepted that initial level of contribution, reassess and determine whether you’re ready to raise the bar, again focusing on easy to do but easy nt to do. Starting slow and improving over time is the recipe for success long-term.

  29. When my husband & I first married back in the 1970′s, we were really poor. Both families were against the wedding (Irish Catholic marrying Southern Baptist) so we could not depend on them for any kind of help. We rented a small apartment and started our life together.

    We were not able to increase our income with irregular working hours, so we found a way to reduce expenses. I usually spent less than the amount budgeted for food and I walked 2 miles to work or to pay a bill instead of driving. The few dollars a week added up, and at the end of one year we had one month’s expenses saved. The emotional relief of having an emergency fund is worth the effort to create one.

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