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This seems like a phrase that gets mentioned in just about every thread here, yet also seems pretty ill-defined.

I'm guessing that it might be that it's basically a way to tell financially irresponsible people that money is important, and they might want to actually have something.

It seems like an idea with a lot of babble behind it, but is really not that important.

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    Your question is so broad that it's unclear. An emergency fund means money set aside in case you need it in an emergency. Whether you think that is important is up to you, but from your question it's not clear what you don't understand about that. – BrenBarn Dec 30 '16 at 22:44
  • @BrenBarn It just seems a little stupid to me to go and put away money for the explicit purpose of emergencies (presumably in a way that's somehow different from how you would normally save money). Seems better to go and treat the money as you would normally, and then pull whatever you need from the money that you had saved. – Stack Tracer Dec 30 '16 at 22:47
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    @StackTracer - ah the glory days of college. Then you graduate, get a job, get a mortgage (maybe), get married, have kids, and realize you have no savings left. OK, that's a bit cynical, but I think you get the idea. – BobbyScon Dec 30 '16 at 22:54
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    @StackTracer: Then probably you already have an emergency fund; you just don't think of it that way. – BrenBarn Dec 30 '16 at 22:58
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    @StackTracer: If you have enough money to live for years with no income, then perhaps you are right. The thing with emergencies is you often don't realize you should have been concerned until the emergency is already upon you. – BrenBarn Dec 30 '16 at 23:07
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An emergency fund is very well defined, both on this site and across the web.

  • What are your monthly expenses? Groceries, bills, etc.
  • If you were to lose all sources of income tomorrow, how would you pay for those items?

An emergency fund is a cash account where you keep money for emergencies so you don't need to take on debt like a loan or credit cards. Car breaks down? emergency fund can help pay that. Lose your job? The emergency fund is there to pay rent and for groceries until you're back up an running.

There are several schools of thought on how much money should be in your emergency fund, but it boils down to how high your risk assessment is. Typically, the average is to have 3 months in cash available at all times (like in a savings account). It'd be better to have more, but that's a typical goal.

You're also asking about investments in the comments. An emergency fund should be readily available. If you already have $10K in savings, set aside what you would need to cover a few months of bills into a cash-ready savings account, then invest the rest. Investments sometimes take time, or have penalties, if you withdraw them.

Additionally, as @JoeTaxpayer so correctly pointed out, getting into the habit of maintaining a separate emergency fund helps protect your other investments from becoming a crutch and instead used to save up for larger things like a house or, especially, retirement.

See also:

What expenses should be covered by an emergency fund

What should I reserve "emergency savings" for?

What expenses do most people not prepare for that turn into "emergencies" but are not covered by an Emergency Fund?

Less than a year at my first job out of college, what do I save for first?

  • but why save specifically in cash, and specifically for "emergencies"? I might have 5-10k lying around in cash so that my debit cards would work and I don't have to deal with the details, but the rest would go to investment accounts and places that actually earn interest rates higher than inflation... Because if it's in cash, you're just losing money. – Stack Tracer Dec 30 '16 at 22:59
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    @StackTracer: That's the sort of thing I mean when I say your original question is unclear. If you're asking about the difference between an emergency fund and, say, investing in stocks, of if you're asking why the emergency fund should be in cash, then you should mention that as part of your question. – BrenBarn Dec 30 '16 at 23:00
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    @StackTracer - If you have 5-10K in savings lying around already, then you have your emergency fund. You're just not calling it that. Your other question was about buying a car. If that eats your 5-10K up entirely, then you have no emergency fund left. – BobbyScon Dec 30 '16 at 23:02
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    A +1 answer, Bobby, but for the newbie, I'd add that it's more than not taking on debt or a loan, It's about having that EF so that these expenses don't get you into the habit of taking money from your retirement savings. (Update - thx for the great edit. those links provide a nice summary of MSE best EF posts) – JoeTaxpayer Dec 31 '16 at 0:51
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    @Stack Tracer: One reason not to have your "emergency fund" invested in the market is what if the emergency happened in 2008? Or in the next severe market downturn? Then you have to sell some of your investment a significant loss. But I agree that having a specific "emergency fund" is more for those who're used to living paycheck to paycheck. – jamesqf Dec 31 '16 at 18:56
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In your comment, you said:

It just seems a little stupid to me to go and put away money for the explicit purpose of emergencies (presumably in a way that's somehow different from how you would normally save money). Seems better to go and treat the money as you would normally, and then pull whatever you need from the money that you had saved.

The problem with that logic is that people save money for many different things. You might save for a vacation, or a new refrigerator, or a new car, or a house, or your kids' college education. If you "pull whatever you need" for such expenses, you may find that when a real emergency occurs, you don't have enough money. The things you used it for may have been legitimate, reasonable expenses, but nonetheless you may later wish you had deferred those expenses until after you had built up a cushion.

So the idea of an emergency fund is to designate certain money that is not to be used for "whatever you need", but specifically for unforeseen circumstances. Of course there can be debate about what counts as an emergency, but the main point is to distinguish saving for planned future expenses from saving for unplanned future expenses.

Note that this doesn't mean the money has to be in a separate account, or saved in any special "way". It just means the money has to be considered by you as an emergency fund. For some people, it may be psychologically useful to put the emergency fund in a separate account that they never withdraw from. But even if you just have all your money in one savings account and you mentally tell yourself, "I don't want to ever let the balance drop below $10,000, just so I have a safety cushion" then you are effectively designating that $10,000 as an emergency fund.

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What an emergency fund is

  • Make an honest survey of your actual monthly spending.
  • Subtract out the monthly cost of luxuries you are really willing to cut during a long-term financial emergency.
  • The total is your expected spending in an emergency month.
  • Multiply this by the number of months of emergency fund your advisor, philosophy or favorite financial guru says you should have (e.g. after the Great Recession, Suze Orman bumped this to 8.)

Now store the money in -- okay here, think about a realistic worst case scenario. Not zombie attack or meteor mega-strike, but the kinds in which you are not entirely helpless: job loss stacked on top of the worst recession since the Great Depression, along with credit drying up so you can't just borrow your way through the hard times. Store the money in an account and investment which is

  1. relatively liquid, meaning you could extract cash value from it fairly easily in a worst case scneario.

  2. Safe -- essentially impossible to lose significant value in a worst case scenario. (or, you only count the part of its value that's sure to be there in a worst case.)

What it's for

If you're much too cool for an emergency fund, then sorry to waste your valuable time!

For the rest of us, it's a planning tool. Even dot-coms do this: it's called a "burn-rate" and they know exactly how many more weeks their VC can fund operations.

Of course in practicality, it may not go to X months of routine expenses. Most of it may get burned up in month 2 on a new transmission. You can't really predict this stuff, the "X month" paradigm is just an arm-wave.

For the financially uneducated, it's also a training tool. In the US, school does not provide financial education. Most people get financial habits from their parents, and like most family lessons, they are deeply emotionally wired, even if they are unconscious of that fact. For instance, some people don't ask for the salaries they deserve, and spend lavishly until the checkbook is zero - they literally push money away.

Suffice it to say, it's a challenge to get some people to even realize that savings is a thing, when they have never in their whole lives been able to hold onto more than $20 for more than a week. The concept of an emergency fund is a sellable way to break through that "I can't save" mental-block.

So I can see where you might think the emergency fund is greasy kidstuff. Fair. But it's not just that, it's also a very practical planning tool.

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Emergency funds

The rule that I know is six months of income, stored in readily accessible savings (e.g. a savings or money market account).

Others have argued that it should be six months of expenses, which is of course easier to achieve. I would recommend against that, partially because it is easier to achieve. The other issue is that people are more prone to underestimate their expenses than their income. Finally, if you base it on your current expenses, then budget for savings and have money left over, you often increase your expenses. Sometimes obviously (e.g. a new car) and sometimes not (e.g. more restaurants or clubs). Income increases are rarer and easier to see.

Either way, you can make that six months shorter or longer. Six months is both feasible and capable of handling difficult emergencies. Six years wouldn't be feasible. One month wouldn't get you through a major emergency.

Examples of emergencies:

  • Job loss. Finance basic expenses while looking for a new job.
  • Major house repair. New roof, furnace, etc.
  • Medical. Particularly if it keeps you from working. E.g. a badly broken leg that requires physical therapy.
  • Sudden car replacement.
  • Kids. For example, you may have to take time off from work to help a child handle a medical emergency.

Why different?

Your savings can be in any of multiple forms. For example, someone was talking about buying real estate and renting it. That's a form of savings, but it can be difficult to do withdrawals. Stocks and bonds are better, but what if your emergency happens when the market is down? Part of how emergency funds operate is that they are readily accessible.

Another issue is that a main goal of savings is to cover retirement. So people put them in tax privileged retirement accounts. The downside of that is that the money is not then available for emergencies without paying penalties. You get benefits from retirement accounts but that's in exchange for limitations.

Are you saving enough?

It's much easier to spend money than to save it. There are many options and the world makes it easy to do. Emergency funds make people really think about that portion of savings. And thinking about saving before spending helps avoid situations where you shortchange savings.

Let's pretend that retirement accounts don't exist (perhaps they don't in your country). Your savings is some mix of stocks and bonds. You have a mortgaged house. You've budgeted enough into stocks and bonds to cover retirement. Now you have a major emergency.

As I understand your proposal, you would then take that money out of the stocks and bonds for retirement. But then you no longer have enough for retirement. Going forward, you will have to scrimp to get back on track.

An emergency fund says that you should do that scrimping early. Because if you're used to spending any level of money, cutting that is painful. But if you've only ever spent a certain level, not increasing it is much easier. The longer you delay optional expenses, the less important they seem.

Scrimping beforehand also helps avoid the situation where the emergency happens at the end of your career. It's one thing to scrimp for fifteen years at fifty. What's your plan if you would have an emergency at sixty-five? Or later? Then you're reducing your living standard at retirement.

Now, maybe you save more than necessary. It's not unknown. But it's not typical either. It is far more common to encounter someone who isn't saving enough than too much.

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