Unexpected expenses, like car repairs or medical bills, can wreak havoc on your financial plan. These emergencies may exceed your cash flow and require funds from other sources. Planning for emergencies by saving for the unexpected can be an excellent way to build a safety net for yourself, allowing you to handle major unexpected expenses without falling into debt. Emergency funds can also help protect against the impacts of temporary job loss, where your expenses are the same, but you have no income or diminished income.

How Much Money Should Be in an Emergency Fund?

The amount that should be held in an emergency fund will vary by person or family. A standard benchmark is to have between 3 to 6 months of living expenses in emergency funds. This is quite a large range for a benchmark, but the appropriate amount of cash to keep on hand for emergencies is based on other personal factors like the stability of a person’s income, the composition of their household, or personal comfort level. For example, if you have a home with two income earners with a steady, regular paycheck, three months of living expenses may be an appropriate benchmark. If you are a single person working as a freelancer with considerable variability in your income, saving six months or more of living expenses can make sense.

Where Should I Keep My Emergency Fund Money?

An emergency fund should be kept in an account that gives you easy access to the money but not so easy that you can conveniently dip into the assets for non-emergency expenses. Liquidity, the ability to quickly convert an asset into cash, is also essential when choosing an account to hold your emergency fund. Of course, the most liquid asset is cash, so having an account with cash or a cash equivalent, such as a certificate of deposit, would offer the most ease in accessing the funds.

I recommend keeping your emergency fund in a high-yield savings account. High-yield savings accounts offer three benefits to holding emergency funds. First, high-yield savings accounts are convenient, making it easy to deposit and withdraw cash when needed. Since your money will be held in cash, there is no risk that you will have to pull money out of the stock market at a disadvantageous time or be unable to sell something when you need cash. Second, the cash is earning interest, so it isn’t unproductively sitting in a checking account for an extended period. Finally, the money in a high-yield savings account is accessible but typically less accessible than a traditional savings account. High-yield savings accounts usually have some withdrawal limits, like six withdrawals per statement cycle, which can help keep you from randomly dipping into the account.

A Final Note on Emergency Funds

Having cash on hand for emergencies is a great idea, but not too much. Using the benchmark of 3 to 6 months of living expenses can also have the added benefit of ensuring you do not have an excessive amount of cash. Having too much cash on hand could open you up to inflation risk, where the purchasing power of your cash is not keeping up with the current costs of goods. Once you reach your target emergency fund amount, additional cash should be diverted into accounts or assets that can earn larger returns by taking on more risk. Cash does not offer comparable returns to riskier assets like stocks or bonds long-term, so ensuring you have a diversified portfolio of assets can protect against inflation risk.

Financial professionals like me often talk about ideals when discussing emergency funds, as with so many other financial benchmarks. However, the key message here is to have some money for emergencies put away somewhere that is separate from your checking account but accessible when you need it. You could set a goal for one hundred dollars, five hundred dollars, then a thousand dollars. Or perhaps you have some savings but haven’t added to it in a while. Consider transferring another $100 to that account or making deposits into that account regularly. Something is better than nothing; set a goal based on your unique situation and begin.