Everything You Need to Know About Emergency Funds

One of the first posts I published on our website was titled Emergency Fund: Your First Financial Goal.  Since creating The Motivated M.D., one of my most frequented topics has been emergency funds.  They serve an integral purpose in asset protection and alleviating financial anxiety.  This week, we publish Everything You Need to Know About Emergency Funds.  This will make the fifth chapter in our Doctor Money content series.  Everything you have ever wanted to know about emergency funds is here. 

Doctor Money: A Personal Finance Guide for Physicians

Previous Chapter:

Chapter 4: How to Write a Financial Plan

Chapter 5: The Emergency Fund

This chapter aims to sell you on the importance of an easily accessible emergency fund.  Almost any personal finance blog or existing literature recommends this concept in some form or fashion.  It makes total sense.  Let’s break it down piece by piece to better understand why housing a large sum of money (separate from any investments or retirement) is a cornerstone to sound finances. 

What is an Emergency Fund?

So, what is an emergency fund, after all?  As you navigate life, unexpected expenses are inevitable.  Nay, I say they are a guarantee.  The air conditioning fails, you suddenly need a new car, you must take a last-minute flight for an emergency need, your roof needs repair, unexpected healthcare expenses… you name it.  As you can see, the world has no shortage of surprises.  How does a physician protect themselves from these unforeseen costs?

Enter the emergency fund.  The emergency fund is an amount of money that is easily accessible and saved strictly to address these unexpected emergent expenses.  As discussed in earlier chapters, much of our living expenses are budgeted for.  Small unexpected expenses should be accounted for if you are living below your means and well within your budget.  Getting your oil changed or having to eat out more during a busy week does not constitute a financial emergency. 

So, what constitutes a financial emergency?  What is this money actually for?

What is a Financial Emergency?

This may seem an elementary question to pose to a reader as motivated as you. However, I think we should set clear expectations on what constitutes a financial emergency. 

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

With this definition, one can understand why I gave the examples alluded to above.  Many can relate to the air conditioning needing to be replaced in summer heat, totaling their car, or being unexpectedly laid off from work.  I have used these examples as they represent situations leading to large expenses that generally cannot be postponed.  Depending on your home’s size, air conditioners can cost upwards of $10,000-$20,000!  Even if you buy a beater, a replacement vehicle will likely run you $5,000-$15,000 or more in our current economy.

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

What is Not a Financial Emergency?

So, if we now have a concept of what constitutes a financial emergency, what is not a financial emergency?  It can be difficult to sit on a pile of money with no definitive plans except the expectation of future disaster.  Do not let this money burn a hole in your pocket.  An emergency fund should be built to offer financial security and asset protection and alleviate some financial anxiety. 

As we will discuss later in this article, there are some gray areas regarding emergency fund use, but I would argue there are some expenses that should not be considered emergency expenses. 

Are you tired of your current vehicle and feel it is time for a new one?  Unless your automobile is becoming a safety hazard or in need of repairs so extensive that it is more cost-effective to purchase another, then upgrading your vehicle is, in fact, not an emergency. 

Gifts of any sort are not financial emergencies.  Christmas gifting is not an emergency.  Buying new furniture for your home or finally getting that 80-inch 4K television, sorry, also not an emergency.  A vacation (unless you are on the brink of burnout and quitting the medical profession) is not an emergency.  You get it.

An emergency fund is not meant to grow exponentially, nor is it expected to plummet.  It is meant to be placed in a safe location patiently waiting for the unexpected. 

Emergency Fund Size

One of the most commonly discussed topics regarding emergency funds is their size.  How much should a physician save to guard against the unexpected?  Ask five different doctors, and you will likely get five different answers.  Most personal finance literature defines amounts by your monthly cost of living or living expenses.  This means an emergency fund should have three to six months of living expenses.  All of your living expenses. 

To realize this amount, you need to look at your budget.  See why I placed budgeting as an earlier chapter?  An honest and comprehensive budget is a prerequisite for building an appropriate emergency fund.  First, You will need to review your monthly budget and calculate your living expenses.  If you have an outlier month, take the average.  This calculation should include everything, like literally ev-er-y-thing that you spend in a month (mortgage, student loan payments, groceries, childcare, gasoline, utilities, eating out, etc.).  Everything.  Have this number for a month’s worth of living expenses?  Now multiply it by 3 to 6, depending on your risk aversion.  That is the size of the emergency fund you should target. 

Here is an example: Your monthly living expenses are approximately $10,000.  I am using this number for easy math.  Then your emergency fund should be anywhere from $30,000-$60,000.  The idea is that should you lose your job, you have enough money to maintain your lifestyle for a quarter or half the year.  A scenario such as this highlights that unemployment is already stressful enough; the last thing a physician should worry about when job hunting is wondering if you can put food on the table and pay your mortgage/rent. 

Where to Keep Your Emergency Funds

Another commonly discussed topic is where to house your emergency fund. Again, it depends on your risk aversion and how accessible the money is. The most important aspect of your emergency fund is that it is available when you need it, sometimes on a moment’s notice.

My wife and I keep ours housed in a high-yield savings account.  We can access this shared account when needed.  It is here that we house our emergency fund savings, alongside our Christmas expenses savings and our vacation fund.  It is nice because we have all our accounts in one (online) place, and we can reach for them if needed.  More importantly, it is a breeze to link our checking accounts to our shared online bank so we can move money over seamlessly if needed. 

One important aspect to touch on is that the location of the fund should be safe and secure and alleviate anxiety.  Some may keep cash buried out back; if that is you, go for it.  I personally chose a high-yield savings account because it has essentially no volatility or risk of loss. However, some would advocate having your large savings make more money for you and thus be housed in an investment account or a money market account.  This is fine, but this decision is largely influenced by your risk tolerance. 

However you keep your fund, the important thing is that the money is easily accessible, safe, and secure enough to keep you from dwelling on it. 

Risk Aversion and Your Emergency Fund

It should be clear that I am somewhat oversimplifying the emergency fund.  There are a number of factors that can, and arguably should, influence how much you save and how you store your funds.  Risk aversion is how to choose to label this. 

With the dawn of the COVID-19 pandemic, the amount individuals choose to keep in their emergency funds has been re-evaluated.  With so many individuals in healthcare either being let go or leaving due to burnout, many relied on their emergency fund to sustain them.  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 drastically influence one’s risk aversion and future planning. 

No perfect amount needs to be saved (but my recommendations above still stands).  How much you keep in your emergency fund should allow you to feel financially secure for (nearly) all catastrophes.  To me, that is at least three months’ worth of living expenses, but maybe closer to six months if you are more averse to risk. 

Aside from the amount you save, the other factor that is influenced by your risk aversion is where you keep your emergency fund saved.  If you are open to volatility and potential lost income but wish to have your money work for you, then maybe keeping it in a taxable investment account of index funds is your choice.  If the risk of money loss in a market downturn puts you off, then housing it in a high-yield savings account should be just fine. 

Either way, allow your comfort with risk to influence how much you save and where you house your emergency fund.  However, remember that this money is not for investments or increasing your yield; it is strictly to sit there patiently until a need arises. 

Use and Maintenance of Your Emergency Fund

As we approach the end of this chapter, the last portion of emergency funds, we will discuss its use and maintenance. 

When that fateful day arrives, and you have an emergency, no worries.  That is what it is literally there for!  Take a deep breath and recognize that you have planned for this.    

When I have to use my emergency fund, I will transfer the amount needed from where I keep it to my checking account.  Now, for the sake of time and rewards, larger expenses are still placed on my cash-back rewards credit card.  This is ideally when credit card reward utilization is best.  I always place whatever emergency expense is needed on my cash-back card.  I will then wait for my emergency funds to be transferred.  I will immediately pay off the credit card once these funds are available in my checking account.  This approach allows me to pay the expense immediately, receive some cash-back rewards, and leave no amount on my credit card.  Free money!

Now that you have dealt with your emergency expense, you need to address how to replenish your emergency fund.  Being the foundation of your financial security, you should prioritize paying back this fund.  I do not wish a financial emergency on anyone; I really don’t wish for two emergencies!  The future is unpredictable, and the only way to be prepared is to plan and keep your fund repleted.  For me, this means not paying extra student loan payments for a month or two until our emergency fund is back to its full amount. 

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

Emergency Fund ‘Gray Areas’

Now that the creation and utilization of the emergency fund have been addressed, let’s talk about gray areas.  There are 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 of living expenses.  Some would argue it should be smaller, somewhere on the order of $10,000-$15,000.  The idea behind this is your money should be working for you.  If an amount as large as 3-6 months of living expenses is sitting in a low-yield savings account, it’s not working for you. 

This money may be better suited in a high-yield investing account (think index fund).  Here, it will make more 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 wholeheartedly disagree with it.  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 is your emergency fund lose money. 

Another gray area concerns debt elimination.  Like 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 large payment 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. 

The emergency fund is the foundation on which you build your financial security.  For many, this is the first step towards alleviating financial anxiety on your path towards financial independence.  Whether you house a small amount or save a year’s worth of living expenses, it will be pivotal to your ability to adapt moving forward. As always…

Stay motivated!

The Motivated M.D.

Additional Resources

An Essential Guide to Building an Emergency Fund (Consumer Financial Protection Bureau)

What is an Emergency Fund and Why Do I Need One? (Motley Fool)

The Average Emergency Fund Size By Age (Financial Samurai)

Next Chapter:

Chapter 6: Protecting Your Ass(ets)

Disclaimer and Limit of Liability

This post (and hopefully its eventual publication) is designed strictly to inform and entertain. I am in no way, shape, or form a financial professional, nor does this site provide formalized financial advice. I do not provide nor engage in rendering legal, accounting, or other professional services. If legal advice or other professional/expert assistance is required, then the services of an accredited professional should be sought. I am not liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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