Life will always try to catch you with your pants down. The best way to be ready is reliable, comfortable underwear that keeps your important things in order at all times. In personal finance, that’s your emergency fund: the base layer nobody sees, that you mostly forget about, and that’s always there when you need it.
Everyday underwear isn’t fun or exciting, but it keeps you operating smoothly. Good underwear makes you feel secure and supported, and a healthy emergency fund does the same. Going without one is nerve-wracking. You’re exposed, very little separates you from the rest of the world, and it’s downright uncomfortable.
How much is enough?
The conventional rule is three to six months of non-discretionary expenses. That’s sound advice, but it ignores two things that matter a lot: how secure your income is, and how you’re wired. Are you the go-to expert in your field, with recruiters in your inbox every week? You’re probably fine near three months. More robot coworkers than human ones, and a basement stocked like a doomsday prepper’s? Bump it to six. Maybe nine.
Non-discretionary expenses are the bills you have to pay every month no matter what: mortgage or rent, health insurance, car payments, groceries, utilities, childcare. Not just what keeps you alive, but what keeps you working. Add them up, multiply by your number of months, and that’s your target. In our house, we add 10% on top, so a surprise car repair or medical bill doesn’t eat into the cushion itself.
What this looks like with three kids
In our house, the non-discretionary list is dominated by one line: childcare for three boys. It’s the biggest bill we have, and it doesn’t pause if a paycheck does. Two incomes help, but two careers also means two jobs that can wobble. That’s exactly why the fund exists: so a layoff or a medical surprise doesn’t force a choice between keeping the kids in care and keeping our investments on autopilot.
The reserve fund lesson
My other money job is HOA treasurer, which means part of every year goes to managing a reserve fund. Big capital repairs don’t wait for a convenient budget year, and the reserve exists so the community can pay for them without a special assessment landing in everyone’s mailbox. A household emergency fund is the same idea at kitchen-table scale: money set aside ahead of time for things you know will go wrong, even if you don’t know when.
Saving isn’t sexy (and it’s not meant to be)
Certain investments are the lingerie of personal finance: exciting, a little risqué (risky), and everybody fantasizes about them. They’re fun, but they don’t do much heavy lifting day to day, and they’re meant for the long term. Your emergency fund, the boxers, briefs, bras, and panties of your financial wardrobe, is the unglamorous hero that keeps everything where it’s supposed to be.
“That won’t happen to me”
When people picture their future, it’s mostly good news. Rarely does the story include a house fire or an employer going under. Those make for good movies, but in your version of Titanic, the ship made it to America, right?
Nobody enjoys thinking about what could go wrong, but things do go wrong, sometimes for a reason and often for none at all. Those moments are hard enough emotionally without a financial crisis stacked on top. So rather than rolling the dice, prepare now. When the inevitable arrives, you’ll be able to meet it head on.
Where to keep it
Emergency money needs to be two things: safe and liquid. Liquidity is how quickly something turns into cash. Your house is about as illiquid as it gets; selling can take months, which doesn’t help with bills due in two weeks. Real estate is a reasonably safe place to hold wealth (few thieves take the whole house), but it’s lousy for emergencies.
What about investment or retirement accounts? Stocks and funds can be sold and settled within a day or two, so they’re liquid, but they aren’t safe for short-term needs. Picture the market crashing and your employer cutting jobs in the recession that follows. That’s where millions of people found themselves in 2008: forced to sell investments at the bottom, locking in losses and missing the recovery. Pull from a retirement account early and you can add taxes and penalties on top.
The right home is cash and cash equivalents. Not a bag under the mattress (unless you really want to), but high-yield savings accounts, money market accounts or funds, short-term Treasury bills, and CDs, keeping in mind that most CDs charge a penalty if you cash out early. These are safe, liquid, and pay some interest, so your money does a little work. Just don’t expect these seedlings to turn into redwoods.
Build your base layer
Once you’ve picked your number, start building. It takes time, so don’t sweat it if you’re not there yet. Rome wasn’t built in a day.
The one thing I’d tell you not to do is what I did early on: over-engineer it. A finance degree will tempt you into scenario models and tracking spreadsheets with a tab for everything. You don’t need them. You need a target number and an automatic transfer that moves money into the account every payday, before you have a chance to think about it. The transfer does the work; the spreadsheet mostly makes you feel busy.
And don’t forget to splurge now and then. Not a new car, but a nice dinner out. Once your base layer is built to size, you should feel accomplished: you’re walking around the world in fresh undies, friend. After that, it’s time to start shopping for the sexy stuff.