Emergency funds are an incredibly useful financial tool. They’re simply pools of money set aside for you when you find yourself in a financial pinch, and emergency funds are easy to start.
As with any financial tool, there are specific practices that are worth considering. How big should they be? Where should I save the money? Why shouldn’t I just use a credit card instead? We answer those questions here.
How big should an emergency fund be?
How much money should I have in my emergency fund before it’s “good enough?” I realize that any emergency fund is better than nothing, but how much should I be aiming for?
You’ll find plenty of recommendations for the amount of your emergency fund, ranging anywhere from $500 to an entire year’s worth of living expenses. With such a huge range, it’s hard to really know what you should be aiming for.
Rather than aiming for a specific total dollar amount, consider a different strategy entirely. Aim to always maintain a certain minimum amount in your emergency fund. A good minimum amount is $1,000 if you’re single or a month’s living expenses if you have dependents, though you can easily change this based on your comfort level. For example, if you have an unstable career, a higher minimum amount may be the right choice for you.
[ Next: How to Start Building an Emergency Fund ]
Your first goal should be to get your emergency fund up to that minimum level as quickly as you can. Make it a priority to make frequent contributions to your emergency fund account until it’s well funded.
After that, select a small amount that you’ll automatically contribute to your emergency fund each week. Maybe it’s $10, maybe it’s $20 — whatever works easily for you. Set up an automatic weekly transfer from your checking account to your emergency fund savings account for that amount. Then, never turn off that transfer. Just sit on it and forget about it.
Going forward, simply never tap your emergency fund for anything other than genuine emergencies, and when you notice that your emergency fund has gone below your minimum, put extra effort in the short term to get it back to that minimum level.
This way, your emergency fund will always have ample money in there for almost any emergency, and you won’t have to continually add money to it again after each and every emergency.
Is a credit card a good emergency fund?
What is the point of an emergency fund if you have a credit card? Can’t you just put emergencies on the credit card and pay them off later?
This works in some situations for some emergencies, but it falls apart far too often for this to be a truly reliable emergency fund.
For example, what if you face an emergency when your credit card is maxed out? What if the credit card network is down in your area, such as during a power outage after a natural disaster? What if your identity is stolen? What if your wallet is stolen? There are many, many life emergencies that can strike that your credit card simply cannot help with.
[ Read More: 5 Best Ways to Borrow Money in a Financial Emergency ]
Furthermore, not everyone is even eligible for a credit card. Many people starting their financial turnarounds have marginal credit and may not even be eligible for one.
For these reasons, a cash emergency fund is the best solution for most people. Cash is available in many situations when a credit card might not work, such as an emergency. Cash does not rely on a financial institution continuing to allow you to use a card. Cash is available to you even when your identity has been stolen.
That’s not to say that credit cards aren’t very useful in many situations. Credit cards can help build your credit history, while cash does not. Credit cards can easily solve some minor emergencies for some people. They’re just not as flexible as cash for the purposes of an emergency fund, and if you want anything from an emergency fund, it’s flexible.
Should emergency funds be at home or in a savings account?
Is it safer to keep an emergency fund at home in a secure place or in a bank account?
The best practice is to spread your risk and have some of your emergency fund in both places, so that in the event of an emergency, you don’t lose access to your whole emergency fund. You’d have to face a disaster of serious magnitude to lose access to an emergency fund both at home and at a bank.
At home, your primary risk in having a cash emergency fund is theft and home damage. A thief in your home presents a risk to an emergency fund kept at home, as does a fire or another disaster.
At the bank, the main risk to your emergency fund is identity theft — someone accessing your account without your permission. There is also a small hurdle for access in some cases, particularly if your bank does not have local branches, as you’re relying on internet access to gain access to your funds.
Thus, to spread out those risks, split your emergency fund in two. Store a portion of your emergency fund — say, half of your minimum amount — in a very safe place in your home that would be difficult for a thief to access and difficult for natural disasters to harm. Cash hidden in a very small, fireproof and watertight container on the bottom floor of your home is a good choice, as it protects your money from water damage, fire damage and all but the most thorough of thieves.
Store the rest of your emergency fund in a savings account, ideally at a bank with a local branch that offers good online banking and a big ATM network, but if there’s no good option for that, choose a reputable online bank with the ability to access your account by phone if necessary.
You’ll particularly want to look for a savings account that offers FDIC insurance (or NCUA insurance if you’re using a credit union), a variety of ways to access your funds, and good customer service, as you want a bank that can come through for you in a pinch.
Do you have any questions? The best way to ask is to follow me on Facebook and ask questions directly there. I’ll attempt to answer them in a future mailbag (which, via full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive many, many questions per week, so I may not necessarily be able to answer yours.