All About Emergency Funds

By Geoff Schaefer

Geoff is a Wealth Advisor with Intergy Private Wealth. He writes for The Steadfast Fiduciary to help people live with an abundant heart, open mind, and boundless generosity.

June 25, 2024

The basics on a foundational planning topic.

In the world of personal financial planning, some of the simplest steps are often the most overlooked. A short list of common oversights are: not having an umbrella policy, not buying long term disability insurance, skipping out on an estate plan, inappropriate investment allocations, and then having too much or too little in emergency funds.

Before I get into what an emergency fund is, let me tell you a few things it is not. It is not a line of credit. It is not a brokerage account. It is not a 401(k)-hardship withdrawal. It is not a phone call to your parents.

An emergency fund is a cash account set aside specifically for unplanned and short-term expenses. Perhaps it is a job loss, a large home repair, or a medical emergency.  All of these could trigger bills that income does not cover. The emergency fund provides a very fast influx of capital that allows you to avoid short-term borrowing options that are often very expensive (i.e. credit cards, lines of credit, payday loans, personal loans). The emergency fund also makes sure your lifestyle can remain steady even in the face of short-term financial uncertainty.

How much should you have in your emergency fund? 3- 6 months of living expenses, but it depends!

You might be saying, just give me a quick math problem. None of this “it depends” stuff.

              It depends on your career, family situation, number of income streams, and even health. Here is a table of factors that may help you determine how much to put away:

3 Month Emergency Fund6 Month Emergency Fund
Single with no dependentsMarried with one income
Married with two steady incomesVariable Income Source- sales or commissions
Steady income source- government or medicalA family member has serious health concerns
Family wealth or trust fund incomeSelf employed or small business owner
Job position is secureMarried with children
High Net WorthJob position is replaceable/ uncertain

You’ll notice a theme that the more variable your income and lifestyle and the more people dependent on your income, the more cash you will want to build up.  When income is more predictable and financial responsibility is low, there is no need for large amounts of cash on the sidelines.

Ultimately, the number for you is a mix of a financial rule of thumb and where you feel most comfortable and confident.  Investing more may not help if you have anxiety every day about the balance of your savings account.

How do I build an emergency fund? There are two parts of this. One where the emergency fund is the priority of your financial plan and the second being where it is built alongside other goals.

Part one: You have little or no cash.  Some sort of buffer has to be in place or you risk turning towards high interest debt to make ends meet.  In this stage, you need to get to a small but safe number as soon as possible.  For many families, this can be as small as a couple thousand dollars.  Investing more, maxing out your Roth IRA and 401(k) can all take a pause as you get your savings account to very low four figure balance.  Once you see a couple thousand in savings, it’s time to pause and reassess.

Now we get into the second part.  You are not quite at 3-6 months of expenses, but you can breathe a bit. Up until now, you’ve contributed to your 401(k) up to the match (this is usually a great idea: More on your 401(k) here) and contributed to savings, that’s it!  You’ve built a small buffer and you need to grow emergency funds more, but you also want to save for your child’s college, retirement, and that dream house. Instead of nearly 100% of savings going into the emergency fund we can cut that number down dramatically. There will still be monthly contributions to cash, but increase your Roth 401(k) by a few percent, make monthly investments into your brokerage account, start paying down those student loans. You will still grow your emergency funds to a target balance, but it does not have to consume the plan. You will be ok with taking more time to get there because other goals and values you have are being addressed.

I have a 401(k) balance or non-qualified investments, should I pull from those to refill my emergency fund?

Good question, and the correct answer is, it depends (I know you all hate reading that from me, but it’s true.) If I had to make a blanket statement here it would be to definitely avoid all retirement accounts withdrawals to replenish emergency funds and generally, avoiding taking from other investment accounts as well.  I’d rather you go back to the last point and slow down your plan to refocus on short-term savings than to pull from investments meant for the long term to satisfy a short-term problem.  What’s the saying? Never make long term decisions based on short term circumstances.  Most times when I see someone who has drained their emergency funds from a move, a big expense, a medical issue, or whatever the case may be, a realistic plan can be built and small adjustments can be made to restore the emergency funds without taking from investments. It’s important to remember that one of the biggest factors for investments is time.  When you take from an investment before its intended purpose and to fill a short-term hole, you are resetting the clock on that money. Read all about taxable brokerage accounts

Long term financial planning has a lot to do about patience.

Do I pay off high interest debt before I build emergency funds?

No, and yes.  Go back to the two parts of emergency fund building.  Do step one right away. Without a modest amount in savings, you’ll just go back to accruing more credit card debt. Once you have that small amount, pause building the emergency funds to the ideal 3-6 month level until you lower and ideally eliminate your high interest consumer debt.

Where should my emergency funds be kept?

This will be short.  A FDIC insured high yield savings account. If you want to get fancy you could keep rolling 1-3 month CDs, but most people have no time that for the miniscule benefit opportunity.  Most people will be best suited for a no fee, no minimum, high yield savings account.  A quick google search will show you some of the top options available. Here are your criteria:

  • FDIC Insurance
  • No fees on transfer
  • No minimum balance
  • High rate of interest regardless of balance

Pick one account and stick with it.  Do not change savings accounts every six months because Amex raise their rate by .1% and Discover is now lower.  The options all move rates according to the same external factors and the difference between a 4.25% and 4.35% interest rate will not be a needle mover in your financial life. Use your time elsewhere.

Last question, when do I use it? Every financial pinch is a little different and not every single one should warrant draining your cash savings. Can this expense be deferred?  So instead of incurring the cost of the car repairs now, can you take the car in a couple months after you’ve saved several hundred dollars for it?  Can you paint the house next spring?  If the expense cannot be deferred, can payment be deferred without interest?  Maybe that new dryer will come with a 13-month payment plan at 0% interest, that might be a great option. If there is an expense that occurs and the only option is paying from emergency funds or taking on high interest debt, you open that savings account right away.  Building it up will be a process, but you have kept yourself in a better financial position.

When we talk financial planning, we usually want to skip to the retirement aspect of it or lowering our tax bill. Some people only want to talk and read about the stock market and which funds you should own in your Roth IRA.  All of those are important parts of planning, but without some foundational planning conversations, those can become moot points. No house you want to live in was built in a day. It took months from the foundation on up.  A good financial plan is not much different and will be the result of ground-up work over the course of decades.

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