Emergency Fund: Your First Financial Goal

Why building an emergency fund should be your first financial goal

What is an emergency fund?

When it comes to personal finance, there are few other places to start than the emergency fund.  Let’s start with the basics. 

As you navigate life, unexpected expenses are inevitable.  The air conditioning fails, you need a new car, last minute flight, leaky roof, unexpected healthcare expense… As you can see, the world can have no shortage of surprises.  How does one protect themselves from the unexpected? 

Enter the emergency fund.  The emergency fund is an amount of money that is readily available, saved strictly for the purpose of unexpected emergent expenses. 

What is a financial emergency?

This seems a ridiculous question to pose to an audience composed predominantly of healthcare workers.  However, when it comes to utilization of your emergency fund, it is important to define when to use it. 

Financial emergencies, as I define them, are any unexpected expense that must be addressed in a timely fashion and whose monetary cost would place one’s budget in jeopardy. 

With this definition, you can understand why I gave the examples above.  Many can relate to the air conditioning needing to be replaced in the heat of summer, totaling their car, or being laid off from work.  I have used these as examples as they represent situations leading to large expenses that (generally) cannot be postponed.  Air conditioners, depending on the size of your home, can cost upwards of $10,000-15,000!  A replacement vehicle, even if you buy a beater, will run you $5000-10,000, or even more in this pandemic market!

I have provided just a few examples above, but hopefully you are beginning to understand the scenarios that would demand you have a sum of money readily available on a moment’s notice. 

What is NOT a financial emergency?

Before we move on, lets also take a quick moment to define what is not a financial emergency.  It can often be difficult to have a pile of money sitting in an account.  Do not let this money burn a hole in your pocket.  An emergency fund should be built to offer financial security and help alleviate anxiety of the unexpected. 

As we will touch on later in this article, there are some ‘gray areas’ when it comes to this funds utilization.  However, I would argue there are some expenses that should absolutely not be considered emergencies.

Are you tired of your current car and want a new one?  Unless your automobile is a mechanical safety hazard or in need of repairs so extensive that it is more cost effective to buy a another car… then it is not an emergency. 

Gifts, of any sort, are not financial emergencies.  Buying new furniture for your home, or finally getting that 80-inch OLED 4K television…I’m sorry, not an emergency.  You get it.

This fund is not meant to grow exponentially, nor it is expected to plummet.  It is meant to be placed in a safe location or account with little to no volatility, patiently waiting the unexpected. 

Where do I keep my emergency fund?

Depending on the literature you read, you may get varying answers on this.  The most important aspect is that the money is readily available, or liquid.  This means that your money should be held in a location that is easily accessible to you and anyone else you deem responsible enough to have access (i.e. your spouse). 

For my wife and I, we chose to use Capital One 360.  With Capital One 360 you can basically open as many checking or savings accounts as needed.  It is here that we house our emergency fund, as well as our holiday fund and our vacation fund.  It is nice because we have all our accounts in one place and each of us can access to them.  More importantly, with Capital One 360, it is a breeze to link our personal checking/savings accounts.  This allowed us to easily move money between locations if needed. 

One important thing to touch on here is that the location of this fund should be safe, secure, and alleviate anxiety.  Some may choose to keep cash buried in the back yard.  I personally chose to keep it in a savings account.  Some may choose a money market account, or in an index fund (more on that later).  Whatever you decide, it should be very accessible.  It should be in a safe location, and it should be secure enough to keep you from dwelling on it. 

How much should I have in my emergency fund?

Great question.  Again, ask five different individuals and you are likely to get five different answers.  Most literature that I have read defines amounts by cost of monthly living expenses.  What I mean is, an emergency fund should have anywhere between 3-6 months living expenses. 

To realize this cost, you need to look at your budget (if you have one) and calculate your monthly living expenses.  Include everything (mortgage, student loan payments, groceries, childcare, gasoline, utilities, etc.)  Literally ev-er-y-thing that allows you to live comfortably for a month.  Have that number?  Now multiply it by 3-6. 

For example, let’s say your monthly living expenses are approximately $10,000.  Then your emergency fund should be anywhere from $30,000-$60,000.  The idea behind this is, should you be laid off unexpectedly, you have enough money to maintain your lifestyle for the foreseeable future?  A scenario such as this highlights that unemployment is already stressful enough.  The last thing you want to be doing while job hunting is wondering if you can put food on the table. 

Post-COVID emergency funds

With the dawn of the COVID-19 pandemic, the amount individuals choose to keep in their emergency fund was re-considered.  With so many being laid off, or choosing to leave their job, many relied on their emergency fund.  For the younger generation, this was the first time they had to lean on an emergency fund.  Actually, having to put these savings to use can high influence how it is viewed.  With the moratorium on federal student loans, many chose to divert those expenses to building a larger emergency fund. 

There is no perfect ‘amount’ that needs to be saved.  It should be an amount that allows you to feel financially secure for a catastrophe.  I would argue that you should have at least three months living expenses.  Anything more than that is icing on the cake and wholly up to your comfort level. 

What happens if I have to use the emergency fund?

Ok, so that fateful day arrives.  An emergency has happened and you need to use some money from your emergency fund.  No worries.  That is what it is here for!  Take a deep breath, recognize that you planned for this.

Using myself as the example, if I have suspicion that some of the emergency fund is needed, I will preemptively transfer the amount needed to my personal checking.  Now, for the sake of time and rewards, large expenses are still placed on my cash-back rewards credit card.  This is ideally when credit card utilization is best.  I always place whatever emergency expense is needed on my cash-back credit card.  I will then wait for my emergency funds to be transferred to my personal checking.  Once these funds are available in my personal checking, I will immediately pay off the credit card.  This approach allows me to pay the expense immediately, receive some cash-back, and leave no amount on my credit card.  Free money!

So now you have dealt with the emergency expense.  Your emergency fund is down that amount.  Being the foundation to your financial security, you should prioritize paying back the funds you removed. 

I do not wish a financial emergency on anyone.  I really don’t wish TWO emergencies on them.  The future is unpredictable and the only way to be prepared is to save against financial disaster.  Part of this is always having the emergency fund prepared.  For me, this means not paying extra student loan payments for a month or two until our emergency fund is back to its initial amount. 

Take comfort in the fact that you have an emergency fund to begin with.  Allow yourself to use it without hesitation when the time arrives, and prioritize its replenishment after use. 

The emergency fund ‘gray area’

Now that creation and utilization of the emergency fund has been addressed, let’s talk about gray areas.  A few things that need to be touched on here. 

One school of thought is that your emergency fund should not be as large as 3-6 months living expenses.  Some would argue it should be smaller, somewhere on the order of $10,000-$15,000.  The idea behind this is that your money should really be working for you.  If an amount as large as 3-6 months living expenses is sitting in a low yield savings account, its not working for you.  This money may be better suited in a high-yield investing account (think index fund).  Here, it will be making more on interest in the market, thus working harder for you.  The difference in interest between a low yield savings account and a mutual fund (especially in this market) on a large emergency fund can sometimes be thousands of dollars!

This is a great point and I do not whole-heartedly disagree.  However, recognize that sometimes having this money in a mutual fund can make it less accessible.  Further, having this money in a mutual fund can also make this fund subject to market volatility.  The last thing you want to watch your emergency fund lose money. 

Another gray area concerns debt elimination.  As with many working towards financial independence, debt elimination is a top priority.  Taking a large portion of your emergency fund (think $10,000-$20,000) and making a large payment towards your debt snowball is very enticing.  Again, not one I completely disagree with.  A payment this large can offer a lot in the way of debt motivation.  The drawback here is that your emergency fund will fall to a smaller amount, limiting your financial options in a catastrophe. 

Take home points

The emergency fund is the foundation to which you build your financial security.  For many, this is the first step towards alleviating your anxiety on your path towards financial independence.  Whether you keep a small amount tucked away or 12 months living expenses, there are a few principles to keep in mind:

• Make sure your emergency fund an amount that brings you comfort and security, I recommend at least 3 months living expenses
• Make sure the emergency fund is kept secure, readily available, and privy only to those you trust
• If you have to take money from the emergency fund, put it back

There you have it, The Motivated M.D. rules for building an emergency fund.  I hope you found this article helpful.  I will continue to publish posts like this in a series I call Motivated Money.  If you found this article helpful please check us out on Twitter, and Instagram.  What have been your experiences with an emergency fund?  Let us know in the comments below!  We would love to hear from you.

Stay motivated!

The Motivated M.D.

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