3 steps to a smarter emergency fund

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Every personal finance blog will tell you that you need an emergency fund, including ours. Recommendations vary, but many experts will tell you to sock away anywhere between three and six months worth of gross income. You’re supposed to put this money into a savings account, where it will sit gathering just enough interest to lag behind inflation.But let’s be real: that’s kind of nuts, right? You’re telling me that, along with my student loan payments, retirement contributions, rent, utilities, and my avocado toast fund, I’m supposed to be saving a big pile of cash that is just going to sit there and lose value?Apparently, America agrees with me, because only 28% of Americans had six months of worth of income set aside last year. There’s a flipside to this, however: 47% of Americans couldn’t cover an unexpected $400 expense, which, in case you couldn’t tell, is a bad thing.There’s a middle ground between those two extremes, and while it does involve an emergency fund, it does not involve saving six months of income in a savings account.First up, make sure you’re living on last month’s income. What does that mean, exactly? It means that you’re not living from paycheck to paycheck, and instead have a buffer of at least one month’s worth of income in your checking account at all times. (Fans of You Need A Budget – my favorite budgeting app – may know this as Rule #4.)Sometimes, the biggest "emergencies" are because of cashflow issues. A surprise car repair, for example, or a late paycheck. By building in a one-month income buffer into your budget, you can absorb some of these smaller unexpected expenses without having to dip into savings or go into debt.You can build this buffer up to be larger, too – depending on how much money you make and how well you manage your budget, you could work towards a two or three month buffer. You can make these all separate goals, which can be easier to tackle than one big six-month goal.Second, budget for expected unexpected expenses. I’m a fan of creating smaller, specific emergency funds for aspects of my life that I know will throw unexpected expenses in my face. For example, home repairs. I live in an old apartment building, and things break. I try to keep two or three hundred dollars set aside at all times specifically for home repairs. For many Americans, a car maintenance fund would be a prudent choice.While these smaller funds may eventually add up to a pretty large sum, it’s psychologically easier to save many small amounts than one big amount. Plus, setting aside money for specific purposes can help you resist the urge to dip into your emergency savings for a non-emergency event.Third, set up an emergency fund – but not in your savings account. If you follow the first and second sets, by this point, you’ll already have several thousand dollars of liquid assets set aside for your buffer and small emergency funds. Why add another ten or twenty thousand dollars to that?Instead, set up an emergency fund at an automated investing service like Betterment, Wealthfront or Robinhood. I know – some financial experts out there would kill me for saying this. Most experts would suggest that your emergency fund be as liquid as possible so that you can access it at any moment. But, as previously established, you already have those liquid funds. Plus, let’s be real, you can just put the expense on a credit card if you really need to, and as long as you have the funds available within the next month, you won’t owe any interest.Betterment suggests that you put 130% of your emergency fund into an investment account that’s 40% stock and 60% bonds. They suggest 130% so that your account can weather small to moderate dips in the market, and they suggest that stock/bond split because it balances the relative safety of bonds with the growth potential of stock. Not only will you be keeping up with inflation, but it’s likely that the growth in your safety net may help you keep up with your rising paycheck and expenses, too.You don’t necessarily need an emergency fund, but you do need to account for unexpected expenses. Building a buffer of liquid assets through smaller and more focused goal-setting is easier – and makes more logical sense – than just throwing a big pile of cash into your savings account. Once you have your liquid asset game figured out, you can start putting your money to work on the market.