039 | In Case of Emergency: Everything You Need to Know About Emergency Funds

We all know that life can throw some unexpected things at us. You want to be prepared when it does.

Having an emergency fund is one way to prepare for the unexpected. Plus, your emergency fund brings you one step closer to freedom because it reduces your reliance on your income.

In this episode, we explore what an emergency fund is, how much to have in your emergency fund, where to keep your emergency fund, and what to do if you don’t have one.

Lightly edited transcript appears after the show notes.

 Topics Discussed

• what an emergency fund is
• how much to have in your emergency fund
• where to keep your emergency fund
• what to do if you don’t have an emergency fund

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Resources mentioned

Lifestyle Freedom Starter Guide

Episode 7: Budgeting for Lifestyle Freedom and Financial Independence

Episode 17: How to Budget Using the Zero-Based Budgeting Method for Lawyers

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The Wealthyesque Community

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Email: hello@rhothomas.com

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Lightly Edited Transcript

Hey friend! Happy Friday!

How are you? I hope you are well.

So things with emergency funds came up in two client sessions this week. And so I wanted to do a quick episode to make sure that I got you this information so that you can learn from what happened with these clients.

We know that unexpected things happen in life right. One thing, currently is the pandemic that we’re all in. Nobody could have seen this coming.

An emergency fund is money that you have set aside for those unexpected expenses or unforeseen events, and it will cover you in case of, you know, job loss or income loss, or whatever other unexpected things come up.

I think sometimes we characterize things as unexpected, but they’re kind of expected right like people talk about unexpected repairs to their home or their cars or whatever.

But we know that cars and houses need to be repaired, although we might not necessarily know when those repairs will come. And so, having something like a sinking fund where you are putting a little money aside over time in case something needs to be repaired is a good idea.

But the point is to have some money set aside because we know that these kinds of things will inevitably pop up.

This was something that came up with one of my clients where this unexpected expense came up, and she did not have the funds set aside and was juggling on credit cards like where to put the expense, and that’s something that we’re working on with building her emergency fund and reducing her reliance on credit cards.

So we’ve talked about what an emergency fund is. How do you decide how much to put in your emergency fund?

I think the amount in your emergency fund will be unique to your specific situation, so I can’t say you should have this amount or even the traditional advice that says you should have three to six months of expenses.

I think that that changes for different people depending on where you are in your financial journey. The further along, you are on your financial journey, then the less likely you or the less you need in your emergency fund. Smaller amounts of money will no longer constitute an emergency for you.

One way to kind of gauge where your emergency fund should be is when you’re looking at your expenses that have to be covered, right, so in the case of an emergency, we’re not so much worried about the fun money, you know, that kind of thing.

We’re looking at these expenses that have to be covered. And if you don’t have a budget, head back to episode 7 and episode 17, and they take you through how to figure out, well I think episode 7 talks about the importance of budgeting and then episode 17 walks you through how to create a budget.

The expenses in there, specifically the expenses that have to be covered, will help guide you on the amount to keep in your emergency fund.

I think other factors also come into play such as your household income, you know, whether it’s a dual income household or a single income household, and then if you’ve got other financial goals, all of that.

So looking at a couple of examples, if you are in a two income household, both of you are in jobs that are pretty stable. You are living within your means living, you know, well below the amount that you’re bringing in, then you might decide that you want to be on the lower end of the spectrum in terms of how much you keep in your emergency fund.

And that’s especially true if you are out of debt and you are in a pretty stable financial position.

My husband and I for years kept one month of expenses in our emergency fund because we were focused on paying off our debt as quickly as possible and because we live on a fraction of what we make.

We had been putting multiple thousands of dollars extra toward our debt payments, and so, if there were some sort of unexpected expense, then our rationale was that we could just make a smaller debt payment in that month, and use that extra money in our budget toward whatever the unexpected expense or emergency was.

And so we did that for a long time, but in the pandemic, when we both got pay cuts, when my job had furloughs and layoffs and that kind of thing, we decided to put a little bit more into that emergency fund because the jobs no longer seemed as stable.

Thankfully we’re on the other side of that now, but that is one place where having that cushion is helpful.

Something else to consider with that or something else that we considered in determining to have one month of expenses in our emergency fund is the interest rates on our debt versus the interest rate that the savings account would return.

The savings accounts at the time were doing like 1% interest, whereas our debts were like 7.9% interest.

And so our thought was if we have more money in the savings account at 1% interest is almost the same as if we had borrowed the amount that’s in the savings account at 7.9% interest to put it into an account making 1%.

So that was part of the reason, too, that we had decided to keep a smaller amount in our emergency fund.

But as I said, once the pandemic hit, and we were looking at potential issues, we decided to bump that up a little bit.

Now let’s say that you are a single income household. You might want to have a bit more in your emergency fund because something else that I didn’t mention with a dual income household is that it’s highly unlikely that both parties would lose their jobs at the same time, which is one of the biggest emergencies or most common emergencies that come up.

And so, if you do have a situation like that where one person loses their job, you’ve still got some income coming in in a dual income household.

But if you are a single income household, then you don’t have that second income to fall back on, and so you might want to have a larger emergency fund so that if something were to happen to that single income, you’ve got more lead time to find another job or another source of income.

That way you can make sure that you will be able to sustain yourself and to pay those bills that still need to be paid, even in the event of emergency.

And if you have, you know, a corporate job or something where you get a steady paycheck. You might decide that you want to have less in your emergency fund than if your income is variable.

When you have that kind of unpredictable income, the risk of an emergency really devastating your finances is greater. I mean at the same time, if you for instance, have your own business you can bring in more income, but that income is not predictable, right?

You might have really high months, but you could have really low months, as well and so making sure that you have that cushion to protect yourself is really important.

Okay, so where should you keep your emergency fund? Your emergency fund should be somewhere where you can easily access it, in a safe account right, not somewhere that is so easily accessible that you’re dipping into it or you’re tempted to move money from the emergency fund for some purchase that you want or whatever.

Some people recommend investing your emergency fund because it’s not keeping up with inflation, and this is what came up with the second client where there’s an emergency fund, but it was invested, and it was invested aggressively, where the client has earned something like 40% return over the last year.

But I asked, like if this balance were to drop to have or to a third, how do you feel about that. And he wasn’t too thrilled with that, and so that’s where we were looking at other places where he could keep that fund, and even if he decides not to transfer the entire thing, just to have at least a portion of it in one of those safe, boring, savings accounts where it’s not so susceptible to the volatility of the stock market.

Your emergency fund is your safety net. Right, it’s not meant to be an investment. In the event of an emergency, you want the funds to be there.

And I’m thinking about, you know the back in March, when the coronavirus hit or back, you know when the Great Recession hit, and there were layoffs and hiring freezes, and the market dropped.

Now with the coronavirus, the market rebounded really quickly, but if you are affected by a layoff or a furlough, or something like that and then your emergency fund is cut in half, you’re losing a huge chunk of your money when you need it.

And so you want to avoid that by having money in a safe account that’s not going to be swinging so wildly that you can access when you want it.

That’s not to say that you can’t also have a portion of your emergency fund, you know, in your investments. I know that sometimes people will have this amount, you know this percentage in a savings account. Because savings accounts do have those lower interest rates, and then they might have another portion in a conservative mutual fund that earns a bit more, but has a larger allocation to bonds, so it’s not as volatile as if it were invested completely in stocks.

Some people also decide to use CDs like certificates of deposit, which also pay higher interest but you have a specific time limit that you’ve got to keep it locked up.

Okay, so what do you do if you don’t have an emergency fund, like how do you fund an emergency fund if you don’t have one already?

So the first thing is you don’t have to go from zero to a fully funded emergency fund overnight. You can take it one step at a time.

If you do have the funds like my client who has the amount invested, he could just pull some out and put it into a savings account, and that’s great.

If you don’t, there are all kinds of things that you can do. If you’ve got things laying around the house that you don’t need don’t want anymore, you could sell those things and put that money towards your emergency fund.

Going back to the budget that we talked about before, hopefully you’ve gotten your budget to a place where your expenses are less than your income, and you can take that extra money that you have, that surplus each month, and start putting that towards your emergency fund until you get it up to where you want it.

If there is an expense that you’re willing to cut for a time, and take the money that you would have put toward that expense towards your emergency fund until you get it to where you want it, you know like all of these different things that you can do to get your emergency fund in place.

But whatever you do, I recommend saving at least a small emergency fund, so that you are prepared when one of these unexpected expenses comes up, right.

Having an emergency fund in place and money that you can access really easily will make sure that things that used to be emergencies are just inconveniences now. It feels so much better to have the money there, knowing that it’s there when you need it than to need it and not have it.

So let’s recap.

1. An emergency fund is just money that you set aside for unexpected expenses or unforeseen events.
2. Only you can decide how much to keep in your emergency fund, but take into consideration the income in your household, your fixed expenses, and that kind of thing.
3. You want to keep your emergency fund somewhere where it’s easily accessible, and you want to make sure that at least a portion of it is in a safe account that is not going to be volatile, like the stock market.
4. If you don’t have an emergency fund, there are many ways that you can get the money that you need to build your emergency fund, such as selling things that you have around the house, saving any surplus in your budget, or cutting an expense for a time, until you get your emergency fund to where you want it to be.

So that’s it for this week’s episode. Join me over in the private Facebook community, The Wealthyesque Community. Let’s talk about emergency funds—if you have one, where you like to keep yours, that kind of thing. And you can find us at rhothomas.com/community.

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Okay friend as we close out, I pray that you feel empowered to take control of your money.

I pray that you will take these tips and make any necessary changes to get your emergency fund where you want it to be.

And as always, I pray that you continue to take steps to regain control of your time, build wealth and live the life of freedom and choice you deserve.

Talk to you later.