Welcome to the final post about emergency funds in our “Am I Ready to Invest?” series! Some quick links to the other three posts in case you need to catch up:
“Am I Ready to Invest?” Part 1: The Emergency Fund (Do I need one?)
“Am I Ready to Invest?” Part 2: The Emergency Fund Amount (How much money?)
“Am I Ready to Invest?” Part 3: The Emergency Fund Account (Where should I hold it?)
The purpose of this post is to address what I would consider to be some frequently asked questions (FAQs) about building and maintaining an emergency fund. As you know if you’ve read through the blog to this point, I argue that having an emergency fund in place is essential to successful investing.
With an emergency fund being essential, I want to make doubly sure that you, the reader, come away from these four posts on the emergency fund feeling like you understand an emergency fund well enough to build one, if you haven’t already, and feeling like you’ve had your questions answered, if you had any.
If, after this post, you still have questions, please feel free to leave them in the comments below, and I will do my best to respond to them. Let’s begin.
Do I really need an emergency fund? That’s a lot of money I normally use to pay the bills having to go instead to building an emergency fund.
Yes, you need one. You should not be doing any serious investing without at least the initial $1,500 emergency fund in place (and even then, you’re going to be splitting money after that point between investing and building the emergency fund further to the level of 3-6 months’ worth of living expenses).
If the only point of action you ever take from reading every single post on this entire blog is to build a $1,500 emergency fund, you’ll be doing yourself a tremendous favor, even if you never invest a single dollar for the rest of your life. In other words, having an initial emergency fund of $1,500 is worth it in and of itself.
But if you intend to invest in order to have any hope of meeting your financial goals, it will be nearly impossible for you to do so without an adequate emergency fund in place to shield your investments from being expended on emergencies.
Do not skip building an emergency fund.
Once I reach the initial $1,500 target, how should I then split my savings between the emergency fund and my investments?
First of all, after reaching the $1,500 target, if you have any high-interest debt, you must eliminate all of it. I’ll be addressing high-interest debt next on the blog, so be looking for that.
You’ll recall that I recommended going ahead and beginning to invest in relatively small amounts after reaching the $1,500 target and while continuing to build up your emergency fund (again, assuming no high-interest debt). That builds discipline in making investment contributions, which is critical to investing success.
Assuming you’ve reached the initial $1,500 target and you have no high-interest debt to contend with, there’s only one wrong way to continue to build the emergency fund and make contributions to investments at the same time, and that’s to contribute more to your investments than to your emergency fund.
If your emergency fund is above the $1,500 initial target and below the 3-6 months’ worth of living expenses goal, a 50/50 split of your monthly savings is fine if you want to split it evenly. A 60% emergency fund / 40% investments split is even better, as is any other split that prioritizes the emergency fund.
Just make sure you avoid contributing more to your investments than to your emergency fund. Remember, the emergency fund is a priority. Once you have it where it needs to be, you’ll be able to focus on your investments. But you must have the emergency fund as a safety buffer for your investments first.
What do I do with my contributions to my investments if an emergency arises and I spend money from the emergency fund?
First of all, if you’ve spent money from your emergency fund on a true emergency, then it’s done its job. That’s a good thing. You set aside money for just such an emergency to prevent it from damaging your investments.
But, of course, once the money is spent, then your emergency fund is now less than what it was. You need to get it back up to its previous level as soon as possible. So once the money is spent, here’s what you do: You cease all contributions to your investments and funnel these contributions into your emergency fund until it has reached its previous level.
As stated in the second post on emergency funds, if your employer offers a match in their retirement plan, you don’t want to leave free money on the table, so still contribute the exact amount to the plan required to receive the maximum match. But then cease all contributions beyond that amount until you have restored your emergency fund to its previous level.
For example, let’s say you’ve done a great job building an emergency fund and have just reached 6 months’ worth of basic living expenses in your emergency fund. Let’s also say that your monthly basic living expenses were $3,000. Your emergency fund sits at $18,000.
But your car breaks down one week after getting your emergency fund to that level, and the bill on the repair is expensive: $1,200. After paying the repair bill out of your emergency fund, your emergency fund now sits at $16,800.
You might be tempted to think at this point, “Well, I’m OK. I mean, $16,800 is still a lot of money, so I’m good. It took me forever to get my emergency fund to that point, though. I’m not going to try to bring it back up to $18,000.”
That’s exactly the wrong mentality.
Emergencies are no fun. I get that. And having an emergency significantly reduce your emergency fund at any time is tough. I don’t like having to draw from our emergency fund any more than you do yours.
But that’s what the emergency fund is there for. It’s to provide the buffer and cushion necessary to keep you from having to pull from your investments and permanently damage them. Not doing everything you can to build an emergency fund back up to where it was prior to the emergency is foolish.
No sugarcoating from me here. Don’t be a fool. Get your emergency fund back where it needs to be as quickly as you are able. Every time.
“Precious treasure and oil are in a wise man’s dwelling, but a foolish man devours it.” – Proverbs 21:20 (ESV)
What do I do if my emergency fund amount grows beyond my goal of 3-6 months’ worth of basic living expenses through being invested in a high-yield savings account or money market fund?
This is a great “problem” to have, isn’t it? First of all, congratulations on having your emergency fund in an account where it can be working for you to make more money. Are you ahead of most Americans in that regard?
Actually, you’re ahead of most Americans in having an emergency fund of at least $1,500 in the first place. Are you even more ahead of most Americans by having your emergency fund somewhere it is earning you additional money? Of course.
So you have two options here with your emergency fund growth above its target level: You could either leave your earnings in the emergency fund account to grow it above your target level as additional security, or you could withdraw those earnings and use them to make an additional contribution to your investments, where they could grow even further.
What you shouldn’t do, of course, is take those earnings and spend them.
What do I do? I take the earnings out on an annual basis and contribute them to my investments.
What if I experience an emergency so severe that it depletes my entire emergency fund and I have to take additional money out of my other investments, such as my retirement account(s)?
This is a tough one. The bottom line is that you have to do what you have to do to meet your needs (and those of your family, if applicable). While pulling money out of your retirement account(s) should be considered the last resort, if you have no choice but to do it to avoid going into high-interest debt or just to put food on the table, you have to.
The good news in such a scenario is that you even had the emergency fund to deplete. Think about what it would have been like had you not had $1,500 or 3-6 months’ worth of basic living expenses set aside in your emergency fund.
In such a scenario, there is an order of priority I would follow in choosing what to sell investment-wise to cover the financial need, but that’s a discussion for later, once you have more investing knowledge under your belt. We’ll get there eventually, but it’s on down the road.
An emergency fund of $1,500 and above is a lot of money. Any tips on how to save that much money when we live with an extremely tight budget?
Another tough one. When money is extremely tight, is it possible to build an emergency fund? I would argue that it is, assuming you’re willing to prioritize what you have to in order to make it happen: adopting austerity for a temporary period to get you there and finding some additional ways to make some extra money.
It won’t be easy. And it will take a mentality of being willing to do what most others will not do, but it can be done.
Here are some possibilities that might you might take into consideration to get you to $1,500 or over some other tree in the path as you work toward 3-6 months’ worth of basic living expenses in your emergency fund:
- A side gig, if able: There are multiple opportunities out there if you choose to go this route. Uber/Lyft driver on weekends? Amazon delivery driver based on available times in your schedule? Online tutor? Online English teacher for Chinese children? Proofreading services? Search online and see if you can find something that works well for you.
- A garage sale with all proceeds going to the emergency fund: Perhaps you do a garage sale regularly or semi-regularly anyway, but in this case, consider one specifically for the purpose of building your emergency fund.
Beyond the obvious items you’re thinking of right now that you intend to get rid of anyway, also think about other not-so-obvious items you could live without if you sold them. The total amount you could receive from such items can add up fast. - Temporarily cutting beloved discretionary expenses: No one likes to go down this route, but if you are planning on a specific period to focus on your emergency fund, consider what discretionary expenses can be eliminated during that time, even if it’s something you love.
Most likely, you could give it up for a temporary period if you had to. For example, could you do without your streaming video service(s) for six months, if you funneled every dollar of monthly fees into an emergency fund? What about not eating out? No daily Starbucks? Some other discretionary expense? - Plasma donation: This may sound like an oddball option, but hear me out. The rates at plasma donation centers will vary, but let’s say, for example, that you found one where you could earn $300 per month by donating twice a week.
If you’re a family and you and your spouse each donated plasma, that would be $600 per month. If you and your spouse donated plasma at this center twice a week for two and half months, you’d have your initial $1,500 emergency fund just from donating plasma.
Again, this may not be the option for you, but I just thought I’d throw it out there, considering the potential benefit, especially if you have no emergency fund at this point and are starting from $0. Plus, you’d have the added benefit of helping others in need of your plasma!
I’m sure there are other questions out there regarding emergency funds, but I hope that I’ve done a decent job of covering the ones that would arise the most frequently. If you have an additional question about emergency funds, please leave it in the comments below. I’d be happy to try to answer it when I have availability to do so.
That’s it for emergency funds for the time being. At this point, you may be wondering if–assuming you have your emergency fund in place–you’re now ready to invest.
Well, you might be, or you might not be. The reason you might not yet be ready is our next topic in the “Am I Ready to Invest?” series: high-interest debt. High-interest debt is a killer–so much so that it will easily destroy any of the good you may be accomplishing through investing.
It’s serious business. We’ll get into the details next time.
I always see to build an emergency fund of 3-6 months of living expenses. However, how does one decide whether it should be 3,4,5, or 6 months? Is 6 months the ultimate goal? Does it depend on age, health, job security, etc? My husband and I are saving up for a house right now and the difference between 3 or 6 months of expenses is a lot of money that could amount to a significant portion of our down payment on a house. Thank you for your work on this.
Great question, Lauren! There is no one-size-fits-all answer to the emergency fund because so many circumstances will vary across individuals. I would consider six months’ worth of basic living expenses to be an ultimate goal for the pure safety, but many savers would perhaps consider that to be too high since it is so much money. Many are fine with targeting three months’ worth. It’s going to vary.
That said, you’re correct that things like age, health, and job security play in role in making that decision. For example, someone with a very secure job is much safer going with three months’ worth than someone whose job isn’t secure going with three months’ worth. In another example, someone with frequent health issues would probably be better off with more in an emergency fund than someone who is very healthy, as the person with health issues is more likely to experience a medical emergency.
Your personal circumstance you’ve expressed here should definitely factor into your decision: You’re trying to save for a down payment on a house. That does complicate matters, in that you’ll want to put yourself in the best possible position for the home purchase, which ideally should be 20% down, so that you have less to pay off over time and can also avoid private mortgage insurance as a condition for the loan.
Something to keep in mind as you work toward your down payment goal is that the lender will be looking into your total financial picture, and the more the lender sees as available for future loan payments, the better. That means that your emergency fund will factor into this. A question to consider: How much will be in your emergency fund after you make the down payment on the house? The lender is going to want to see at least 2-3 months of mortgage payments available as ready cash, whether that’s just in an emergency fund, or spread out across an emergency fund and your general checking/debit account.
I know that’s a lot to think through, but just try to balance it out as much as you can. It may mean delaying making the down payment on a home in order to shore things up a bit more. Or it may mean you’re already closer than you think. Let me encourage you not to be discouraged if it means you need to delay the down payment. Better to be in a good financial position going into the home purchase after a longer period than to rush things and enter into the home purchase in a worse financial position, then experience a financial emergency that puts you behind on mortgage payments.
I wish you the best as you decide what to do and implement the decision!