Define: Emergency Fund

An emergency fund is a reserve of money set aside to cover unexpected expenses or financial emergencies that arise in daily life. This fund serves as a financial safety net, providing individuals or families with peace of mind and financial security during times of crisis, such as job loss, medical emergencies, car repairs, or home maintenance issues. The purpose of an emergency fund is to avoid the need to rely on high-interest debt or liquidate long-term investments to cover unforeseen expenses. Financial experts typically recommend setting aside enough money in an emergency fund to cover three to six months’ worth of living expenses, although the exact amount may vary depending on individual circumstances and risk tolerance. Building and maintaining an emergency fund is an essential component of sound financial planning and helps to ensure financial stability and resilience in the face of unexpected events.

Also known as an eFund, an emergency fund usually consists of cash reserves valued at 3-6 months of basic living expenses. Like insurance, you don’t touch it until you need it, such as after a loss of a job or a sudden disability that renders you unable to work for substantial enough pay to meet your current needs. Note that “basic living expenses” are usually considered to consist of the minimum needed to pay for the essential monthly bills, including mortgage or rent, auto payments, consumer-debt minimum payments, utilities, and food.

Since an Emergency Fund is pretty much intended to sit idle until you need it, many Fools stash it in a high-yield money market account at a banking institution of their choice. (If you are interested in opening such an account, you may be able to get a referral from another Fool, through which you both may get a bonus interest payment.)

Many people do not have enough cash to immediately fund an Emergency Fund, so they establish a savings goal and make regular monthly payments. In addition to establishing a savings goal for an Emergency Fund, some Fools establish other savings goals, such as household funds, vacation funds, auto funds, home down payment funds, engagement funds, etc.

While some may treat an emergency fund as more of a household fund or petty cash fund, dipping into it for short-term unexpected expenses, a classic emergency fund is never touched until that “rainy day” comes, complete with drenching floods. The danger with using an emergency fund for short-term expense “loans” is that you may not be as diligent at paying yourself back once the expense has been covered. Then, when the true rainy day arrives, you are left with nothing but a torn and broken umbrella with which to battle the onslaught.

One size does not fit all in the emergency fund area. You need to adapt it to your particular situation. What kinds of events are most likely to come up, what costs are likely, and how will you deal with them?

Examples: Your car breaks down. A family member is ill and you must make a quick trip to see them. Your television is stolen. Your apartment is flooded. You break your leg and can’t work for months. etc etc

If you have equity assets, usually you can arrange to cover things given a bit of time, but you need something to cover that first month or so. A credit card can be enough in some circumstances. Some use bond funds. Many have check-writing services that let you simply write a check when you need cash. The funds earn interest until the check clears. Carrying a balance in an interest-bearing checking account or in a passbook savings account or money market account used to be recommended, but with interest rates so low, those choices are almost painful.

This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

This glossary post was last updated: 10th April 2024.