How Much Do You Need In Your Emergency Fund?

Emergency Funds - How Much Should You Save?

The pandemic taught us a lot of financial lessons. With the whole world shut in their homes, everyone approached finances a little differently. For those that lost their jobs, it was a horrible financial struggle that hopefully found a little relief with the American stimulus payments.

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For those lucky enough to keep their jobs, it gave us a chance to reevaluate our finances and decide what to spend (and not spend) money on. And apparently it wasn't just me doing this: Savings rates for the average 18+ American jumped 10% in the pandemic for a few reasons:

1. There wasn't much to spend money on. With restaurants and bars closed, spending in those categories took a nosedive,

2. The lack of going to a physical office stopped the daily $5 lattes and work lunches where you're peer-pressured into buying a $14 salad,

3. Bored shut-ins had more time to look at their budgets and realized "Holy Christ I have no money"

4. No one could travel, saving potentially many thousands of dollars in a yearly budget.

The pandemic taught us a lot about saving and spending

The Pandemic Savings Boom

This is a little bit of a blessing in disguise. The pandemic ravaged pretty much everything, but the savings rate increase may have dug some American's out of the paycheck-to-paycheck lifestyle. In fact, data from 2019 shows that 61% of millennials couldn't cover a $500 emergency if one arose, and would likely put it on a credit card, incurring massive interest in the process. So how do you avoid putting unnecessary financial strain on yourself while paying for the emergencies in your life? You create an emergency fund!

What Is An Emergency Fund?

An emergency fund is a separate bank account that you dedicate solely to emergencies, including job loss, medical bills, emergency home repairs or a similar situation.

The common wisdom from financial experts everywhere is to save between 3-6 months of living expenses in a side savings account for a rainy day. That could include emergency car repair, home emergencies, a medical emergency or the loss of a job. Emergencies do not include: purchasing a pandemic pet or taking advantage of the sale at Gucci.

3-6 months of bills is daunting as hell. For some people, that's $5,000. For others, that could be $20-$30,000, and that's scary stuff. How am I going to save that much? How do you eat an elephant? Same answer: one bite at a time.

Related: The Easiest Ways to Save Money In 2022

Some experts recommend starting small and getting to a $1,000 milestone in a separate savings account. Truist Financial's money expert Brian Ford calls this a "financial confidence account," and it's appropriately named. Having an extra $1,000 in the bank will help you sleep deeper than an Ambien. How do I know? Because my side savings account saved us last year.

Using Your Emergency Fund

Getting older brings with it a lot of baggage. Want to build the American Dream? That usually involves home ownership, maybe a spouse or partner and potentially a furry friend. I'm lucky enough to say that I have all of these and am on my way to building the life I want to live. Then, inconvenience after inconvenience began to strike.

Last July started like any normal day; with a walk around the neighborhood with my dog. I noticed her acting strange, and decided to take her to the vet. Fast forward through some blood work and the poor thing has an infection. Luckily, it's quick and easy to take care of, but that also translated to $300 I wasn't budgeting for.

The next morning, we woke up to some HEAT. In classic Georgia fashion, it was 89 degrees at 9am, and our room felt like it. Our air conditioner stopped working. After two more days of sleeping in what felt like Satan's sauna due to the July 4th holiday, we got the HVAC repairman out who broke the news that we need to replace the system. The bill for this one? $4,000.

Finally, I just purchased my car form the lease program I had for the last three years. It's a good car, so I decided to buy it out and pay it down and maybe aim for a Tesla in a few years. However, since I leased the car to my now imminent buyout, the state of Georgia has now instituted an "ad valorem" tax rate to cars, both new and used. This tax is a kick in the teeth once you register the car at the DMV, as they collect the check from you then and there. And the tax for my particular car? Right around $850.

So let's add up my week from hell: $300 for the dog, $850 for the car and $4,000 for the air conditioner. This gives us a grand total of: $5,150 of unexpected bills. This is where the emergency fund comes in. Thankfully, my wife and I are diligent in our finances. We both make a decent living and are careful with our spending and saving rates. Thankfully, my wife is better at this than I am. And while our finances, and our confidence, took a major blow this week, our forethought and setting ourselves up for success has helped us come out on top.

The Security of an Emergency Fund

The Dark Side of Compounding Interest

Let's consider for one brief, scary moment, that I did not have an emergency fund to cover that $5,150, and I was living paycheck-to-paycheck like many Americans. That means that I would have had to put that money on a credit card, and likely would have been unable to pay that down anytime soon.

We could cut back on going out to eat and maybe save on some groceries, but I'd have to pay it off in installments back to American Express, which means I would incur interest over time that would snowball. This is the dark side of compounding interest, and oh how very dark it could be...

That's right! If I were to scrape an extra $100 per month out of my budget to pay down this debt, I would still incur a MOUNTAIN of interest payments. I would be paying nearly double, just to cover these expenses. All the while, I'd be losing sleep, increasing my stress and in all likelihood having relationship issues stemming from this debt.

Should I Invest My Emergency Fund?

No! You should not invest your emergency fund in the stock market or any other asset like cryptocurrency or real estate. This is for two reasons:

1. Long term, investing is a great idea. Short term, investing can be very volatile. In the event that you have an emergency during a stock market correction or crash, you can be left with less money than you need.

2. Selling your investments in order to fund an emergency is a taxable event, often by way of short-term capital gains tax. This could potentially save you from the emergency, only to kick your debt down the road when your taxes are due.

The Bottom Line

Debt can be a very, very bad thing. When it's attached to a high interest rate, the speed at which compounding interest can screw you is faster than Charles LeClerc around Melbourne, and you might not be able to catch up. This is the importance of an emergency fund. It's a safety blanket, circus net and Hollywood airbag rolled up into one, tidy account that should sit there and act like your shield. Start one now. You won't regret it.

Related: You Shouldn't Pay Off Your Mortgage Early. Here's Why

Do you have an emergency fund? Are you starting yours now or working on building it up? Let me know in the comments below! And don't forget to sign up for my email list so you can get these in your inbox as soon as they post!