Bridging The Gaap

What is an emergency fund?
An emergency fund is an account with money in it that is to be used only in an emergency. You should have access to the money in the account at all times, but you must be disciplined enough not to touch it unless it is really necessary.

What’s an emergency?
An emergency is any bill or cost you weren’t expecting, and/or would not be able to afford to pay normally. Some good examples include:

• unexpected medical bills (follow the link for a post about my $925 medical scan!)
• a problem with your car
• needing to replace an appliance or other item quickly
• legal/professional fees
• unexpectedly high bill for utilities/cell phone/internet/whatever
• job loss 
• moving costs  (thanks Flexo!)
• death / disability (thanks LivingAlmostLarge!)

 
Why do I need one?
Poop happens. Random, weird stuff happens at random, weird times, and all the planning in the world cannot account for all the randomness of the universe. Establishing a good emergency fund won’t protect you from all the unexpected financial hardships you’re likely to encounter, but it will in most cases be enough to smooth you through life’s rough patches. 

How much should I have in my emergency fund?
In total, your emergency fund should hold at least 3-6 months full living expenses. The “original” purpose of an emergency fund was to provide a financial cushion when people lost their jobs. Frankly, I’d prefer 6 months rather than three. Living expenses include everything from rent/mortgage to utilities to food to car/cellphone/cable payments: it is literally all the money you would need in an average month, times 6.

I also like to tell people that in addition to those 6 months living expenses, they should probably try to add another $3000 - $10,000 to their emergency fund.

The reason is this: what happens if you encounter an unusual financial hardship while you’re out of work? If your emergency fund only has enough for your living expenses, and something weird happens, you may not be able to pay for it. So I like to tell people to work on adding at least $3000- $10,000 extra to their fund (especially if you’re in the United States where healthcare costs are so high), which will cover the cost of the unusual financial hardship, and still keep your 6 months living expenses intact.

Can I have more than one emergency fund?

Absolutely!  If you anticipate other specific emergencies, set up a separate emergency fund just for that, so that you won’t have to dip into your main fund. For example, if you have a car which you suspect will require maintenance at some point in the future, set up a fund specifically for your car. This is a seperate account from your main emergency fund holding your 3-6 months living expenses. With ING it’s easy to set up sub accounts, and to name them to reflect their specific purpose. Click here for BTG’s ING subaccount tutorial.

What kind of account can I use for my emergency fund?

You can use any bank account for your emergency fund, but many people choose to open one with an online bank like ING direct for several reasons:

1. The money will be sitting there between periods when it is needed, so you may as well earn a little interest on it. Online banks tend to offer higher interest rates.
2. You don’t want account fees eating into your emergency funds. Online banks tend to have much lower fees. Some even eliminate them entirely.
3. It can take several days to transfer funds from the online account, which is good if you are impulsive with your money. Having to wait for the funds for a few days means you’ll be less likely to dip into your emergency fund for impulse buys. If you need access to emergency fund very quickly though (say less than 6 days), you should keep it in a normal bank account that you can access quickly.
4. It’s very easy to set up automatic deposits into an emergency fund.

How do I start an emergency fund?

1. Consider your needs. If you think you will need access to the emergency fund quickly, consider using a  low fee savings account from a traditional bank. If you think you could afford to wait a few days for the funds, you’re better off with a high interest, no fee savings account from an online bank.
2. Find a bank that you like. Shop around. I like ING, but there are many other banks to consider. Consider fees, interest rates, and ease of use.
3. Open an account at the institution you’ve chosen to house your emergency fund.  
4. Set up automatic deductions from your regular bank account to your new emergency fund. Online banks tend to make this very easy, as do some regular banks. Call your bank or look online to find out how to do this if you are unsure.
5. Sit back and relax…you’re on your way to financial independence!

How long will it take me to complete my emergency fund?

Remember, Rome wasn’t built in a day: Emergency funds can hold a substancial amount of money, and this takes time to accumulate. The earlier you start, however, the sooner you’ll get there. Even having a little bit of money set aside for emergencies is better than having no money set aside for emergencies.

Heck, if you drink soda, you can start by putting away as little as 2 dollars a day, which can add up to thousands as time goes on.

Now it’s your turn! Have I missed anything? What has your experience been with emergency funds? Post your horror/success stories below!

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