An emergency fund is often the main line of defense guarding your long-term investments. It’s what confronts threats of credit card debt, repels stress around finance, and generates momentum by reminding you of your ability to prove discipline. What is an emergency fund? How can you start one? How much money should you put into one?

Disclaimer

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Past performance is not indicative of future results. No particular result can be guaranteed. All investments involve risk, often including a potential loss of principal.

What is an emergency fund?

An emergency fund is a savings account in a liquid form, such as a high-yield savings account, that is there to cover unforeseen circumstances. It’s months’ worth of expenses set aside for emergencies, keeping you away from high-interest debt or having to liquidate long-term investments. The last thing you want in what’s likely an already hectic period is to have your decision-making impaired through stress, and for the result of your decisions to derail your financial plan even after the emergency has been handled.

How can you start an emergency fund?

You can start your emergency fund now. Typically, your emergency fund will be housed in a savings account. You don’t want uncertainty associated with the tool that is meant to offer dependability. I use a high-yield savings account to combat the uncomfortable thoughts of missing out on higher returns. A quick search of “high yield savings accounts” (I like to reference NerdWallet) will show you popular banks with reviews and their current rate of interest. You could also open a separate savings account through your current bank. Any emergency fund is better than none, regardless of the rate of return.

How much money should you save?

The ideal emergency fund balance should quell your worries sufficiently and actually cover you when (not if) it’s called upon. Most guidelines suggest 3-6 months of expenses. This amount can vary depending on the reliability of your income, your ability to produce additional income if necessary, and the amount of risk you are taking. A “longer runway” may offer further comfort if you are entering a period of increased risk or uncertainty.

In what way is your emergency fund a form of insurance?

You could argue whether or not financial progress could ever be “easy”, but it can undoubtedly be simplified. With the right systems in place, you can achieve most of your goals by simply sticking to the plan. Things that cannot be planned, such as the unforeseen events we’ve been referencing, will be your largest obstacle, assuming willpower holds strong.

An emergency fund acts as a safety net. It prevents you from needing to drag funds from their assigned role. This will allow you to continue pacing as expected – “insuring” your calculations remain applicable. You’re also “insured” against high-interest debt, as you shouldn’t be forced to swipe credit cards or take whatever loan is available to address immediate concerns. “Insurance” for your mental health shouldn’t be overlooked. It’s of great benefit to sleep well and declutter your headspace, allowing you to narrow your focus on the things that matter most.

What are three questions to ask yourself before you spend your emergency fund?

How can you determine when it’s justified to dip into your emergency fund? It’s a good idea to have rules in place that prevent you from overusing this account, so that there’s actually money there when you need it. Here are three questions to ask yourself to help determine if you should use your emergency fund:

• Was this expense foreseeable?
• Can I come up with the funds elsewhere?
• How does this affect the pacing of my other financial goals?

These questions should show you whether you could plan better for the future, if you have any other options to consider, and keep your financial future top of mind.

In summary

An emergency fund can be the difference between a good night of sleep or the difference in retiring years earlier. It’s a non-negotiable part of your financial health from start to finish, and it will almost certainly pay off (literally) when facing what could have otherwise destroyed you. Outside of an employer-sponsored 401k plan, an emergency fund will be step #1 in achieving your money goals.