What is an emergency fund, really?

A cornerstone of our philosophy here at Fortuna Money is that we want to help you make the most of life’s ups, and prepare you to ride out the downs in a position of security and stability. In practice, that means one of our key recommendations is for you to build up a nice cushy emergency fund (e-fund, for short) so you can manage serious, time-sensitive, unexpected problems.

This guide will help you identify how big your emergency fund should be, where you should keep it, and when you should spend it…. so you can build your emergency fund and move on with your life.

Most clients I work with are already on board with this plan and many have money in savings, but they are often kind of fuzzy about how much of that money is really “for emergencies” and how much is earmarked for their upcoming bathroom renovation. That’s super normal, but not necessarily super helpful.

The emergency fund is an anti-anxiety strategy. You might be a habitual over-saver or someone who worries that they should always be putting money aside “for a rainy day.” We don’t want you over-saving for emergencies because you’re missing out on bigger potential returns offered by other savings vehicles. (And if you can say “I’ve saved enough,” you also might be able to let yourself have more fun.) If you’re an under-saver who enjoys the feeling of freedom, I want you to make a nice cozy safety net as a gift to your future self, who won’t find their future style cramped by an emergency (and the accompanying financial stress). Even skydivers have reserve parachutes just in case Plan A doesn’t work out.

Before I start shuffling money around, I gotta know: where do I put this emergency fund?

We recommend you keep your emergency fund in a high yield savings account (HYSA) that is at a different bank from the one you use for your daily checking. The Fortuna family is currently using Marcus and we’ve been happy with it (top of the list here, but not the highest APY at the moment). The interest rate on HYSAs isn’t anything to write home about, but it’s typically better than checking or regular savings, and you want to have your emergency fund somewhere slightly separate from your day-to-day finances so you’re not tempted to fold it into your regular operating expenses. 

We recommend that you keep your e-fund in savings – never in any type of investment vehicle like index funds (which we normally love) or CDs or bonds (which we don’t recommend anyway). We don’t want money that we might need within five years invested in anything that might carry a risk of short-term loss, even a theoretically “low-risk” vehicle.

The e-fund isn’t there to make you money. That’s why we cap our emergency fund at a fixed recommendation. When you right-size your emergency fund, you can then move on to invest in something else that offers great returns.

When should I start my emergency fund? 

Everyone who has expenses should have at least a beginner e-fund – what we call a “buffer fund.” This is the first thing we’d like to see you do, even before paying off debt. If you’re earning more than about $20,000, we recommend saving up $1000 to start. If you’re earning less than that, aim to save up a single paycheck.   

  • If you’re contributing to retirement and you don’t have an e-fund yet, pause your contributions and use that to build up your e-fund. There are many people who don’t have an e-fund but have good retirement savings, and find themselves tempted to take early withdrawals or loans on their retirement accounts when emergencies arise. We almost never recommend that you do that – the potential penalties and risks are too high when you start messing with retirement loans. Build an e-fund first! 

Then, we encourage you to get serious about paying off your non-mortgage debt. Debt payments chew into your savings power – for needs AND for fun goals. If your non-mortgage debt is eating up even 10% of your income, it can hurt your ability to get approved for something like a mortgage. And as anyone who’s ever been in debt can tell you, it can definitely crank up your stress levels to start getting late fees, high interest charges, calls from collectors, and dings on your credit score. (Remember, as we talk about here, payment history is 35% of your credit score — the biggest component – and credit accounts can legally be reported as late as soon as your account is even 30 days past due, which could totally happen in an emergency.) The best way to manage that stress? Pay off your non-mortgage debt! 

After that, we recommend scaling up your e-fund to your target number… and this requires knowing your monthly expenses. 

Wait… are you going to tell me that I need a budget? 

No, I’m going to tell you that you need a spending plan. At minimum, you need to know how much you spend in an average month. If you’ve already paid off your non-mortgage debt (congratulations, you magnificent creature!), there’s a good chance that a spending plan was a big part of your success, so this next part will be easy. 

Can I just use my monthly income to calculate how much money I need to save? 

So, you can, but you don’t have to. If you use that number, you may be over-saving. 

If you’re out of non-mortgage debt, that means you’re probably living within your means, and there are probably a few nice-but-not-totally-necessary expenses in your plan. So look at your monthly spending plan… and then imagine you won’t have any income next month. What might you cut out/pause/scale down/postpone/trim/reshape to get through a paycheck-less time? 

We don’t have to be totally brutal here. It’s important to keep things that are key to your well-being (gym memberships, having-fun-with-friends money), and that are aligned with your values (gifts, donations, buying local/humane/ethically sourced, etc). Make sure you keep your sinking funds going for any irregular expenses. Plan to pause retirement contributions, and look for ways you can lighten up non-essential costs. 

Once you’ve figured out what that light month looks like, you’re ready to go. 

I did it! I know how much I need to live lighter without losing my mind. Now what?  

Awesome. Your “light” budget number is what we’ll use to calculate your e-fund target number. 

If you have not been contributing to retirement each month, save up 3 months of your light monthly expenses. Then, start contributing to retirement. If your employer offers a match, contribute up to the match. If your employer doesn’t offer a match (or doesn’t offer retirement benefits), set aside 5% to contribute to your own retirement funds. I don’t want you leaving free money and compounding interest on the table. 

There’s a great economic term – “precarity,” which is a little more elegant than “being precarious” (unstable, likely to fall) and a little more clever than “uncertainty.” Precarity in this context is tied to uncertainty about employment or income. For many of us, the last two (or fifteen) years have left us all feeling precarious in unexpected ways. There is absolutely no shame in having a high-precarity life, but I’d like to see my high-precarity friends with a bigger safety net. 

If you have a low-precarity situation, your savings goal should be 6 months of light expenses: more than one income stream, extremely stable job (like the military), no dependents, big family safety net? You’re probably good with 6. 

If you have a high-precarity situation – only one income stream, or volatile job(s), or you own your own business/are self-employed, or several people depend on you for health and well-being – then we recommend pushing through until you hit one year’s worth of light expenses. It might feel excessive, but your long-term well-being will thank you. 

And now… you’re done! Time to dial up your retirement savings and start moving towards other goals! 

Ok. I’ve got a big, juicy emergency fund. When should I let myself spend it? 

Emergency funds are for serious, time-sensitive, unexpected problems that you can’t pay for using your current month’s cash flow. It’s usually to cover a one-time event, but it can also support you in the event of longer-term issues (like job loss). 

Emergency funds are NOT an opportunity fund – “well, there’s this great deal on something I want, so let me just get it now!” We are not opposed to having an opportunity fund, but they aren’t the same thing. 

Here are three questions that we ask before we use money that’s in our emergency fund: 

  • If I don’t spend this money to solve this problem, will it affect my household’s health, safety, or earning ability? 
  • Do I have to solve this problem immediately, or can I wait and save over time to address it?
  • Can I find any of the money to solve this problem in my current month’s cash flow by moving things around? 

If the answer to all three of those is “yes,” then it’s probably the right time. Here are some examples of how this might play out, but your answers to the above questions will tell you what your own threshold is!

Emergency: you blow a tire on your only car and you don’t live in a walkable area. If you don’t fix it, your household’s health and safety will be affected because you won’t be able to get to the places you need to go, like your job. You have to solve it immediately because you have no other way to get around, and your budget’s maxed out this month. 

Not an emergency: you get your car inspected and your tires are down to 4/32 tread depth. It’s important to your household’s health and safety that you replace them soon, but it doesn’t have to be immediate. You can afford to put aside $150 each month to save up for a new set. 

Emergency: your AC dies on an August afternoon and you live in FL. 

Not an emergency: your AC dies on an unusually warm October afternoon and you live in Charlotte. 

Emergency: your computer dies; you’re self-employed and you need it for work. You need some type of solution ASAP. Maybe you don’t want to get the brand-new top-line laptop of your dreams yet, so you decide to pay for a repair or a refurbished model.

Not an emergency: your dishwasher dies. It’s inconvenient and frustrating, but your household’s health and safety is probably not in danger. 

  • It has been brought to my attention that while this is not the end of the world, it can definitely land in “straw that breaks the camel’s back” territory. I will go on record here and say that our dishwasher was out of commission for most of the first quarter of 2022. It was incredibly frustrating, we used a lot of disposable dishware, and if we didn’t have a home warranty that we were waiting on to cover the repair cost, we would have definitely gone out of pocket to replace it. However, if we hadn’t had the home warranty, I think we would have tried to cash flow it rather than use savings. That being said… there are people and households for which a dead dishwasher would absolutely constitute an emergency, and I salute you and honor your needs.

Emergencies outside your household are a special case. For instance, if you are a key support pillar for an ailing parent who lives independently, their emergency might well be your emergency. On the other hand, if someone close to you loses their job and you feel guilty because you have “all this money in savings,” that’s not technically your emergency. You can absolutely help them if you have surplus resources (and want to), but the e-fund is one of those “put on your own oxygen mask first” situations.

This is another reason not to over-fund your e-fund — you can leave more money available for generosity. We believe generosity is really important, but you won’t be able to help anyone if you wind up overwhelmed by your own emergency. It’s also much easier to quiet any inner scarcity-monsters you may have around generosity if you have a clear idea of what “enough” looks like for your household and know that you truly can afford to help someone else.

I spent some e-fund money on a legitimate emergency. What do I do now? 

Replenish it, baby! If it’s going to take you more than two months to get back to your target number out of your usual monthly cash flow, we recommend that you pause your retirement contributions according to the guidelines above to catch up. 

Will my target number always be the same? 

Not necessarily. It’s worth revisiting this process periodically to evaluate how much money you really need in there. If you haven’t touched your emergency fund in several years and your two kids are out of daycare now, your monthly expenses are way lower, so your fund can shrink. If you left your super-secure day job for an amazing self-employment adventure, your precarity has gone up, so your fund probably needs to grow.

This might all sound a little bit complicated here because I’m covering a lot of possible scenarios, but things get much simpler once we’re looking at one specific situation. If you’d like some help walking through this process, I’d love to guide you through it in a complimentary Big Financial Picture session

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