Emergency Fund: Not about emergencies?

Emergency funds are arguably the ground floor of healthy finances. At least, it’s on the first floor 2 story house. Or something. They afford you *time* to recover from or find a permanent solution to an emergency or a major change in your life, as well as security in knowing that if times get difficult, you can take a breather without having to worry about money.

You may be confused by typical recommendations, which say something like keep [3-12] months of expenses in [checking, savings, investments, credit] account and [do/do not] use it for infrequent but somewhat predictable expenses like car maintenance, sinking funds (i.e. saving for a house downpayment), annual doctor’s visits, taxes (oh, geez), etc.

All these options are perfectly valid and depend on your situation. Let’s explore what factors you may want to consider when establishing your emergency fund.

AMOUNT

What sort of emergency are you preparing for, and how much would it take to help you solve or recover from it? The amount you keep could be dependent on a number of months worth of expenses or on a total value that you could see yourself needing in an emergency. For instance, if you have a very stable stream of income and support, and you know you could figure things out quickly in a time of true emergency, 1 month of expenses might honestly be enough. If you have less predictable income, you would want to keep enough on hand to get you through lean times, so maybe 6 months makes sense. Maybe your biggest concern is healthcare costs or having to book a last minute flight for a family emergency, so you keep on hand the amount that would cost – which may even double as or be in addition to, say, a “3 month’s expenses” emergency fund.

LOCATION

Preferred location of the fund is based on how quickly you would need liquidity, and how much risk you want your emergency fund to be exposed to. You should also be considering whether or not you want to split your fund over multiple types of accounts. I think it makes sense in a lot of scenarios to put 1 month of expenses in a checking account to prevent accidentally overdrawing your account, another 2-6 months in a savings account for short term emergencies, and keep another 6 months in a brokerage or Roth “retirement” account for longer or larger emergencies. People who are very financially secure (say, with plenty of investments and owning equity in a home) sometimes even treat their Home Equity Line of Credit (HELOC) as an emergency fund, knowing and accepting the risk of liquifying investments if an emergency arises.

PURPOSE

This section is more about semantics than anything. What counts as an emergency? If you keep both your fund for truly unpredictable emergencies in the same savings account as you keep your growing downpayment for a house, do you consider it all your “emergency fund”?

Honestly, who cares? If you’re happy with your plan, I’m happy. So what’s your plan?