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Personal Finance FAQ Series: What is an Emergency Fund?

“The shortest period of time lies between the minute you put some money away for a rainy day and the unexpected arrival of rain.”
– Jane Bryant Quinn

Your grandmother always talked about saving for a rainy day. What exactly does that mean? How much should we save for that proverbial rainy day? In this episode of the personal finance frequently asked questions series, we look at emergency funds and what they mean for you and your family. If you want to see an example of an appropriate time to use your emergency fund, check out this video, where I answer if you should use your emergency fund if you have lost your job.

What is an Emergency Fund?


The transcript for this video follows below.

Tell me if something similar has ever happened to you. You’re sitting in your house one hot, sweltering summer day, and you notice that the house doesn’t quite feel as cool as it should. Like a lobster being boiled in water, you didn’t notice it was getting hot until nearly too late. You walk over and look at the thermostat and it’s 85 degrees, but the fan is blowing full blast.

Your air conditioner has kicked the bucket. That’s a $3,000 bill you didn’t put in this month’s budget. How do you pay for it?

That’s where the emergency fund comes in. The emergency fund is money that you have set aside that will allow you to pay for a large, unexpected expense in cash. The other main purpose of the emergency fund is to provide you with funds to be able to pay your bills in the event that you lose your job. That’s why it’s also referred to as a rainy day fund.

The usual rule of thumb is to keep 3-6 months of expenses in your emergency fund. While that is a good start, I recommend keeping even more in liquid assets so that you can use paying in cash as a negotiating strategy for large ticket items such as furniture or elective surgeries.

Where do you keep your emergency funds stashed? Should you invest them in the stock market? No. I recommend you use a money market fund which has limited check writing abilities as the place where you stash your cash. The idea is that you need to be able to access the cash quickly and easily if there is an emergency.

Also, it needs to be accessed in case of a real emergency, such as having to fly home for a funeral or the unexpected loss of a job. Getting a bigger television for your man cave is NOT an emergency.

What questions would you like to see me answer? Leave me a comment and let me know!

By

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

2 replies on “Personal Finance FAQ Series: What is an Emergency Fund?”

To me, an emergency fund is job loss, injury, divorce, lawsuit, accident, etc.,

Great video! I think sometimes people have an emergency fund, but dip into for things that could have just been saved up for.. car repairs, having a baby, gifts, etc.,

Hi Savannah – Being a Georgia boy, I appreciate your name! 🙂

It’s so easy to conflate infrequent expenses with emergencies. I agree with how you categorize emergencies. The others categories where people dip into the funds are better budgeted for as infrequent expenses. If you’re having a baby, you generally have 7-8 months warning that it’s coming. We know car repairs, Christmas, and the like happen, so we need to budget for it beforehand.

Basically, an emergency fund, to me, is insurance against losing your job. For everything else, you can buy insurance, although if you need insurance for liquidity before you get reimbursed, then you can use it there too. A good example is when a derecho hit central Virginia. People who had sufficient liquidity were able to avoid suffering, while those who did not were forced to sleep for days in their powerless houses while a record heat wave rolled through.

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