The Boring Newsletter, 12/22/2024

Hi Friendos,

Today’s topic is the all-important emergency fund. If you have your emergency fund totally dialed in, this one is not for you, but if not, read on!

What is it? A chunk of money that is set aside in case of “emergency.” Emergency is an unanticipated expense that you must pay for but do not have enough money to do so in your “regular” cash flows.

• Example #1: You have a medical event and the ambulance that picks you up is out of network and balance bills you $3,500. You don’t have an extra $3,500 in your monthly budget, so you use money in your emergency fund to pay the bill (after exhausting appeals with the insurance company and ensuring you really truly are on the hook for this).
• Example #2: Your car stalls out and you need some repairs to get it running again. The car isn’t that old so you weren’t expecting any expensive repairs just yet, but you have your emergency fund to draw on. You are able to have the mechanic do the $900 of work right away and only need to find a ride to work for a couple days.
• Example #3: Your relative dies and you need to buy a plane ticket to attend the funeral. You do not have an extra $750 lying around but your emergency fund comes to the rescue.
• Example #4: You are laid off from work (no severance) and it takes you 10 weeks to get another job. During those 10 weeks you still need to pay rent ($1500/month), buy groceries ($500/month), and pay your utilities ($160/month). You use up most of your emergency fund, but continue to pay all your bills in full during this entire time, phew!

Why is it important to have an emergency fund? Look at those examples and decide if one of those things, or something similar, could happen to you. Yes! The answer is yes of course they could. You need an umbrella because someday it is going to rain. When it does, you do not want to put it on a credit card, raid your retirement savings and incur penalties for doing so, or be boxed into some other financially harmful action. Instead, you want to have your emergency fund sitting there, ready to leap into action for you at a moment’s notice.

When you build up an emergency fund, you are purchasing your future security. If you don’t have a fully funded emergency fund, ask yourself if whatever you are buying is more important than your future security. If you are buying current security, like paying for groceries, then that is more important than future security. If you are buying entertainment or spending on other discretionary items, ask if you value that thing more than you value your future security. I know that’s a tough stance but I stand by it.

Who needs an emergency fund? Everyone. If you have debt, you need an emergency fund to avoid going deeper into debt when you have an unanticipated expense (a financial “emergency”). If you have no debt but are spending all of what you make every month, an emergency fund prevents you from going into debt when some unanticipated event happens, which it will, eventually. If you have no debt but instead have substantial savings and investments, I still think you need an emergency fund. Consider how you will feel if you need cash fast and are forced to liquidate investments. If you have substantial savings, forgoing a little bit of earnings on that cash is not a big deal to you. An emergency fund provides peace of mind in any number of possible circumstances. If you have your own business, your business should have its own emergency fund. If you own rental real estate, you should have a separate emergency fund just for your real estate.

How much money should be in an emergency fund? Enough cash to cover 3 to 6 months’ of your required living expenses, whatever that amount is in your life right now. So consider: rent, utilities and all other regular bills, periodic bills (like if you have car insurance that is paid every 6 months), groceries, transportation, required clothing, etc. The concept is simple, but lots of people don’t actually know how much they spend each month or of that amount, how much is required vs. discretionary spending that could be cut if needed.

Why 3-6 months? That should be enough time to find a new job and pay for your life requirements in the meantime and enough money to cover other unexpected expenses. If your emergency fund is too small, you’ll get wet when it rains. If it is too large, you deprive yourself of the financial benefit from investing that money (think about hauling around a novelty-size, super huge golf umbrella).

How should you decide on an amount within the 3-6 month range? Think about factors specific to your life. For example, if your income is very stable and it would be easy to get a new job, you can lean toward the 3-month end of the range (2-earner households tend to have more income stability than single-earner households). If your income is variable or it would take you a long time to get a new job, lean toward the 6-month end of the range. 3 to 6 months is not a scientific rule, it’s a guideline. If you really want a 9-month emergency fund, ok. If you want 2 years and are not retired, that seems like too much and you probably need to grapple with some fears around money.

When should someone build up an emergency fund?Right away. Emergencies can happen any time, sometimes more than one at the same time, and they don’t care if you want to spend money on something else first because emergencies are not people with feelings. You should prioritize your future absolute-must-haves before other spending. Safety first.  

Where do I keep this money? In its own account that has no other purpose except to hold your emergency fund. It can be either a high-yield savings account or a money market mutual fund. It’s important to use a separate account because (i) it is too cumbersome to track the amount in your emergency fund if it is comingled with other money, and (ii) it is too tempting to spend it if it’s just sitting there in your regular account.

You can and should establish a link between your emergency fund account and your regular checking account so that when an emergency crops up, it will be easy to transfer funds. When you need to access money in the emergency fund, you can have use of funds more quickly if you “push” money from your emergency fund to your checking account (initiate the transfer from your emergency fund account) vs if you “pull” it into your checking account from your emergency fund (initiate from the checking account). This article explains in detail. You should be able to find a financial institution that will process your ACH transfer requests within one business day. If you feel nervous about fast access to your emergency fund, go ahead and practice a transfer from emergency to checking and see how it goes. (Then move the money back!)

What happens next after using the emergency fund? Your top priority with your next paycheck(s) is to replenish the emergency fund back to its original level (3 to 6 months of required living expenses). This might take a little while depending on the size of the emergency and the tightness of your monthly budget. You might need to pause making extra debt payments in the meantime, or pause saving for retirement. That’s ok – purchasing your future security is extremely important.

In 2025, I hope we all have fully funded emergency funds that we never need to use.

-Stephanie

p.s. Do you have a “Real ID” or U.S. passport? It matters because, as Gothamist reported, “If you miss the May 2025 deadline, you will not be able to fly domestically or enter federal buildings without a Real ID or passport.” The exact deadline is May 7, 2025. If your driver’s license or state ID has a star and/or flag on it, you are all set, but if not, check out details here.