How Much Money Do You Really Need in Your Emergency Fund — and What's the Best Way to Achieve That Savings Goal?

June 17, 2020

As sure as there are sunny forecasts, there are those days when it doesn’t just rain — it pours. Out-of-the-blue occurrences like an auto accident, an unanticipated medical expense, or a job loss can put you in a precarious position, one in which unpaid bills accumulate and imperil your financial health.

Just as no meteorologist can control the weather, no one individual can make the economy turn on a dime. However, acknowledging that financial emergencies are inevitable is the first step toward making them less distressing.

Read on to learn how to save for an emergency, whether it’s possible to save too much when you should dip into those savings, and more.

What is an emergency fund?

Your emergency fund is a cash supply that you set aside to ensure that you can cover certain unplanned expenses. Therefore, an emergency fund is a dedicated fund. It is not the only savings account you manage, but rather a savings account you manage separately.

“Cash supply” in this instance doesn’t mean paper money and coins exclusively. It means liquid assets. Your liquid assets are those you can quickly access and convert to the actual dollars and cents you need to settle your accounts.

Liquid assets include cash itself as well as funds held in a checking, savings, or money market account. Some stocks and bonds (collectively known as marketable securities) also qualify as liquid. Depending on your situation, your emergency fund might contain a mix of all of the above.

Why do I need an emergency fund?

No one can plan for every circumstance or contingency. But planning is the key to achieving your savings goals, both short-term — like paying for that vacation abroad — and long-term, such as retirement.

Think of your emergency fund as an insurance policy you take out on your financial planning efforts. All it can take is a cracked engine head, a broken water heater, or a root canal procedure to cause your planning efforts to go awry. Having recourse to an emergency fund can help you get your financial planning efforts back on track more quickly.

For example, you may be able to pay for an emergency expense with a credit card or by securing a personal loan. But doing so can prolong the financial pain of an emergency, adding interest to the principal you couldn’t cover with the liquid assets at your disposal.

How much money should I have saved in my emergency fund?

Most financial planners agree that your emergency fund should contain enough cash to cover between three and six months of household expenses.

What counts as a “household expense?”

“Household expenses” — also sometimes called living expenses — encompass the cost of basic needs such as food and shelter. That includes your mortgage, rent payments, utilities, groceries, and transportation expenses (e.g., car payments).

However, living expenses do not include the costs associated with supporting a specific lifestyle. Gym memberships, Netflix subscriptions, and daily Starbucks fixes do not qualify as living expenses.

How do I calculate three to six months of household (or living) expenses?

The answer to this question will depend on your earnings (income, etc.) and existing financial obligations. It will also depend on how much budgeting you already do. That said, we can use a mix of real and hypothetical averages to illustrate how you might calculate this figure.

The average annual salary in Texas is $65,000, or just over $5,400 per month before taxes. The two most widely employed household budgeting plans are the 60/20/20 rule and the 50/30/20 rule. In each instance, the larger number (60, 50) represents living expenses or non-discretionary income.

Following the 60/20/20 rule, one month of emergency funds totals approximately $3,240 (60 percent of $5,400), three months adds up to $9,720, and six months tops out around $19,440.

Following the 50/30/20 formula, we obtain the following numbers: $2,700 (one month), $8,100 (three months), and $16,200 (six months). 

If looking at those totals leaves you feeling sticker shock, don’t worry. Instead, commit to reviewing your budget — or making one. Even the most sophisticated emergency fund calculators are of limited usefulness unless you can feed them accurate figures.

How can I start saving now for an emergency?

To build your fund, you will need to deposit money to your dedicated emergency savings account. If you have a lump sum you can use to establish your fund, doing so is not a bad idea. However, most individuals add to their emergency fund by making regular — weekly, bimonthly, or monthly — contributions. Setting up a recurring transfer using your bank’s digital banking tools is probably the easiest way to ensure a consistent flow of liquid assets to your emergency fund.

Where should I keep my emergency funds?

Building your emergency fund also entails choosing the right kind of savings account. You want to select an account that gives your money the best chance of making more money on its own, whether that’s by earning interest or dividends. This passive income can help your emergency fund grow more quickly as well as more speedily recover should you have to withdraw from it.

Some of the best options for emergency funds are savings accounts, money market accounts, cash round-up accounts, and certificates of deposit (CDs).

What is a savings account?

A savings account is a trusted traditional savings tool with an attractive interest rate and a low minimum opening balance.

When shopping for a savings account, be sure to read the fine print. Look for information about compounding frequency, compounding periods, and any minimum balance or transaction volume requirements. What appears to be a favorable rate may reveal itself to be less so in light of the financial service provider’s terms and conditions.

What is a money market account?

Money market accounts are much like savings accounts, but with a few important differences.

Money market accounts typically earn higher rates of interest than savings accounts.

These rates are keyed to the value of investments in liquid, short-term markets such as cash, cash equivalent securities, and low-risk securities like U.S. Treasuries.

Money market accounts often come with additional restrictions that may not apply to savings accounts. For example, you may be limited to a certain number of monthly transactions, or be required to maintain a higher monthly minimum balance to avoid incurring a service fee.

What are cash round-up accounts?

Cash round-up accounts employ an algorithm that automatically rounds up the amount of each transaction to the nearest dollar and invests the difference into an interest-bearing savings or money market account. For instance, if you spend $21.25 to fill up your gas tank, your bank will round the transaction up to $22 and invest 75 cents.

Cash round-up accounts can be powerful savings tools if you use your bank-issued debit card to make most purchases.

What is a certificate of deposit (CD)?

A certificate of deposit (CD) is a federally insured savings account with a fixed interest rate and date of withdrawal. CDs generally offer higher interest rates than either savings or money market accounts. However, they are less liquid. You will incur a penalty for withdrawing funds from a CD before its maturity date.

CD terms typically range from three months to five years, with longer terms providing a higher return on investment.

Some investors will “ladder” their CD investments. They will divide one sum of money between several CDs with different terms. As investments in those short-term CDs mature, you can then decide to “upgrade” to a higher-yield, long-term CD, or reinvest in another short-term CD to preserve your liquidity.

For more information on the pros and cons of CD laddering, consult this article published by

How can I save for my emergency fund?

First, be consistent. Saving for your emergency fund goal can seem daunting, even if you aren’t starting from zero. But if you commit to making small, regularly scheduled investments, you’ll begin seeing steady progress. $5 per day might not seem like much, but the savings habit you’re developing will prove just as valuable.

Secondly, leave your money alone and let it grow. Adopt a “set it and forget it” attitude toward your emergency fund. By keeping it compartmentalized from your other accounts, you’ll find it easier to resist the temptation to dip into it for non-essential purchases. Also, bear in mind that “forgetting it” also means making automatic contributions. If you give yourself the option to deposit money into your fund each week or month, you’re also giving yourself an excuse for not doing so.

Finally, be vigilant about your spending and always look for opportunities to redirect funds to your emergency savings account. One great way to do so is by participating in a 30-day spending challenge. Become a more mindful spender by limiting yourself to cash transactions for a month. Dine at home, then take the amount you would spend on eating out and set up a recurring weekly contribution. Or experiment with replacing your brand-name purchases with generic alternatives.

Should I invest in the stock market to grow my emergency fund?

Remember: your emergency fund needs to be a source of passive income that’s both liquid and shielded from risk. Stock market investments are liquid and can generate much more passive income than either a savings or money market account. But stocks are exposed to risk in ways that those other investments are not.

Nevertheless, to balance liquidity, passive income, and risk protection, you may wish to spread your emergency fund over several different accounts. Success here requires a degree of financial know-how and the time to manage a mix of investments whose value can change from day today.

If you want to accelerate your fund’s long-term growth, CDs represent a better risk-adjusted option than stocks or mutual funds. Combining a three- to five-year CD purchase with a cash round-up account or savings account can be an effective two-pronged emergency fund growth strategy.

Is it possible to have too much money in an emergency fund?

Absolutely. Again, your emergency fund should not be your only savings account. Inflation will eventually catch up and surpass the interest your savings earn. That is, over time, money loses its value as commodity prices continue to rise.

Of course, right-sizing your emergency fund in times of uncertainty can be quite challenging. A good rule of thumb is to place your emergency fund within the context of your bigger savings goals. Don’t miss out on an opportunity to contribute to a retirement savings account such as an IRA because you’re anxiously guarding against every imaginable worst-case scenario.

If you find yourself beating your emergency fund goals, congratulations on your financial acumen and discipline. Now, it’s time to determine where any surplus can be more productively invested.

When should I use my emergency fund?

Despite what its name suggests, your emergency fund isn’t a disaster fund. On the other hand, not every unexpected expense counts as an emergency. Again, your budget supplies the proper context for determining when to draw money out of your emergency fund.

Two conditions should apply before you seriously consider utilizing your emergency fund.

  1. Your regular budget cannot accommodate an unforeseen expenditure.
  2. You can avoid incurring additional debt by paying cash. If used irresponsibly, loans and credit cards can cause what doesn’t technically count as an emergency today (even if it feels like one) to become one years later.

Ultimately, when you choose to use your emergency fund is a personal decision, one dictated by your specific financial circumstances. Create guidelines for yourself, hold yourself accountable, and have a plan for refunding your emergency savings account as soon as you’re able.

Whether you’re ready to create or keep growing your emergency fund, Guaranty Bank & Trust offers a wide variety of products and services that can help you achieve your financial goals. If you have five minutes, you can get started today. Or, if you have questions or concerns, any of our friendly, caring, and collaborative bankers would be happy to speak with you. Just call our Customer Care Custer at 888-572-9881. We look forward to hearing from you.

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