The emergency fund is the bread and butter of beginning personal finance. It is the first thing any person looking to build a secure financial future needs to attend to. And though it’s the first form of savings you’ll develop, I believe you need to keep it for the rest of your life. As you build more wealth, it will become a much smaller piece of your finances, but it will remain an important one.
In an age of online brokerages where you can easily and quickly manage your money yourself, I’ve often asked myself if an emergency fund is really necessary. After all, if there were a dire emergency, I could use my credit card to pay for it, and then move money from one of my investments into my checking account within a day or two. So why is an emergency fund necessary?
I don’t think anyone would question that emergency funds are an absolute necessity for people just getting started in life. You need to put aside money in case your car breaks down, you have to go to the emergency room, you lose your job, or a whole host of other scenarios. Here’s why you absolutely need an emergency fund if you’re just getting started:
Emergency Funds for Beginners
They’re easy to start
If you’re just getting started with your first job, or if you’ve been working for a while and have never saved anything, an emergency fund is an incredibly easy way to start saving. You don’t need to know anything about investing, you don’t need to sign up with a new bank, and you don’t need a lot of money to start it. You can simply open up a new savings account with your existing bank and transfer some money in. Most banks will let you open a savings account with a very small deposit, usually from $25 to $100 depending on your bank. Some banks will even let you open an account with no initial deposit. So there’s really no excuse to not have an emergency fund. Surely you can find $25 to start up an emergency fund and an additional $25 to put into it each month. Start small if you must.
They’ll be there for you in an emergency
This is kind of the obvious one. It’s the purpose of an emergency fund. When unexpected costs come up, having an emergency fund will keep you from taking on debt to pay the bills. If you have a hefty medical bill and no savings, you’ll have no choice but to take a loan, or charge it to your credit card. You’ll then be stuck paying back the loan with interest, and if you’re someone who had no savings to begin with, you’re certainly not going to get ahead financially if you’re paying interest. Which brings me to…
It’s more fun to save money than spend it on interest charges
At first, it may seem like a chore to put aside money each month for savings. It requires sacrifice and discipline. You may have to occasionally say no when your friends ask you if you want to go out for drinks, or when you’re thinking about buying another pair of shoes. Saving money doesn’t sound very fun. But what’s even less fun is paying 20% interest on credit card charges because you didn’t have enough cash to replace the radiator in your car. Once you get started building up your emergency fund, it will start to become fun to watch it grow. Watching your emergency fund balance growing > watching your credit card balance growing.
But what about the people who have already built up substantial savings? They have several funds they could tap into in case of an emergency, so it becomes a little more difficult to justify the paltry interest you’ll receive in an emergency fund held in a savings account. For these people, the benefits of an emergency fund are a little less tangible, but I believe they are still very real. Here’s why I think you should keep your emergency fund even as your assets grow:
Emergency Funds for the Advanced
They allow you to keep your targeted savings targeted
When you set up a savings or investment account to save for a particular goal, be it a vacation, a car, a down payment for a house, retirement, or just general long-term savings, it hurts to have to borrow money from it. If you’re saving up for a house for instance, you’ve probably run the numbers dozens of times and know exactly how long it will take you to build up your down payment. You probably day dream about the day you can say goodbye to your landlord and buy your very own house. Imagine how much it would suck if an emergency popped up and you had to borrow money from your down payment fund to pay for it. True, by setting aside money for an emergency fund, you might end up diverting some money that would have otherwise gone to your down payment fund each month, but it’s a huge difference psychologically.* Diverting small amounts each month is something you can build into your savings plan, so though you might not get to your goal quite as quickly, you still know when you’re going to get there. If you don’t have a separate emergency fund, you never know when something will happen and you’ll have to borrow money from your down payment fund, so when it does happen, it completely throws off your plans.
The more assets you have, the more can go wrong
This is the most tangible reason to keep your emergency fund. If you don’t own anything, the only emergencies you need to worry about are medical and job loss, but once you own a car and a house, and have children whose medical emergencies you need to worry about, there are a whole lot more things that can go wrong. Your car can break down, you could need to replace your washing machine, you could have a plumbing problem, your child could need braces, the list is endless. If after reading the last paragraph you still thought that you’d be fine borrowing from one of your targeted savings accounts to pay for emergencies, just think about how likely it is that emergencies will pop up and you’ll start to see why keeping that emergency fund around is critical.
They can double as an “opportunity fund”
If you’re already saving for many different goals, you might not be putting aside money for the next great opportunity that comes along. It’s easy to save for the things you’re planning on buying, but we often forget to save for the unexpected things you may want to buy. If the stock market takes a tumble and suddenly stocks are on a huge discount, you can use some of your emergency fund to take advantage of it. If an exciting business opportunity presents itself, your emergency fund will be there to let you get in on it. This is certainly not to say that you should completely drain your emergency fund to take on a new opportunity (after all, you could have an actual emergency the very next day!), but it’s an argument for keeping a large emergency fund. If you’ve only got one or two months worth of expenses in your emergency fund, you’re not going to be in a position to take advantage of opportunities. If you have a full year of expenses covered, you’ll feel much more comfortable using a portion of that money to take advantage of a great opportunity when it arises.
You’ve crossed all your t’s and dotted all your i’s
This is a completely intangible benefit, but there’s something to be said for having done everything you’re “supposed” to do. Knowing that you have an emergency fund, targeted savings accounts, long-term savings, and retirement savings gives you the peace of mind that you’re not missing anything. Maybe you think it’s silly to keep money in an account yielding 1% interest when it could be earning more elsewhere, but your gut tells you that having that emergency fund means you’ve done everything the experts tell you to do, and that helps you sleep better at night. If you go against the experts’ advice and then wind up in a situation where you wish you had an emergency fund, you’ll beat yourself up over it. (You also probably get sick of having to constantly explain to people your rationale behind not having an emergency fund.)
If you’re just starting out, do you have an emergency fund? Do you find it satisfying to put money in there and see it grow? Does it give you peace of mind that you’re prepared for the unexpected?
If you’re more advanced and have a sizable net worth invested in multiple places, do you still keep an emergency fund? Why or why not?
*Random tangent: In college I participated in a very interesting study. I was given two $10 bills and put in front of a computer where I was shown a series of items that I could purchase at a reduced price. For each item, I could either say “yes, I would buy that item at that price” or “no, I wouldn’t buy that.” There were two sets of items, so one $10 bill was for the first set, and the other $10 bill was for the second set. At the end of the study, the experimenter picked two items at random, one from each set, and if I had said that I would purchase those items, I really did purchase them (and get to keep whatever money was left over), and if I said I wouldn’t purchase them, I got to keep the money. I ended up with a wireless keyboard and mouse and $12. (Have I mentioned participating in studies is awesome?)
I didn’t get a thorough debrief, which makes me really upset, because I really wanted to know what they were studying! My theory is that half the participants were physically given money beforehand, and half weren’t. The experimenter really stressed the fact that the $20 he gave me was mine to keep, and I should treat it like my money, so I think they were studying something about the effects of actually having the money in your hands. My guess is that they expected the people who were physically given money to be much choosier with how they spend it, whereas the people who didn’t have $20 sitting in their pocket during the study were more willing to say they would purchase things.
So when the money is already in your targeted savings account, you’re really choosy about what you’ll spend it on. But money that hasn’t been physically put into your targeted savings account yet is still uncategorized, so psychologically, it’s much easier to use that money for something else, namely an emergency fund.