Why is it important to have a personal emergency fund, how do you build one, how much should it be, and how do you protect it from relentless inflation?
At first glance, it may seem unnecessary to explain what a personal emergency fund—often referred to as a “rainy day” fund—is, but that’s only on the surface. Yes, it’s money you set aside for unexpected situations, whether it’s job loss, illness, or urgent expenses (like repairs to your home or car), but the matter isn’t as simple as it appears, especially if you want to manage such a fund optimally.
There are several important questions. First, how much money should be in it? And second, where should you keep it?
As expected, economists’ opinions vary, but the general advice is to save enough to cover about 3 to 8 months of living expenses. That means you should have enough to get through such a period—whether it’s to find a new job or another source of income—and then start rebuilding the fund.
If you’re not dealing with job loss but instead face a major one-time expense, the fund might be used up right away, but hopefully it will cover the emergency. But what if multiple problems occur at once? What if, for example, illness coincides with loss of income? These situations are harder to plan for, but it’s still important to try—if for nothing else, then for peace of mind. The feeling that any emergency could plunge you into crisis is a heavy burden—and that burden won’t lift itself. Every day, people find their lives turned upside down by unexpected events, and some even end up homeless.
It’s helpful to read real-life stories of people who seemed to be living normal lives—maybe even middle-class—only to hit rock bottom overnight. Maybe it was escalating debt, medical issues, a death in the family, or a false sense of job security. A lot can go wrong suddenly, for an individual or an entire family.
We could also talk about how today’s system offers little social protection when things go badly—but it doesn’t look like that’s changing anytime soon. The so-called “social safety net” is becoming more full of holes, so people are slipping right through it. In such circumstances, the only one you can rely on is yourself. That’s why a rainy day fund is essential.
But how can you even start building a fund if you live paycheck to paycheck, like so many people today? You’re not alone. Even in the supposedly richest country in the world—the U.S.—this is a huge problem. According to their central bank, over a quarter of Americans wouldn’t be able to cover an emergency expense of just $400. That figure jumps to a massive 45% among unemployed individuals.
Sadly, many of them will face such or even larger expenses, and those events could permanently wreck their lives.
So, what should you do if you don’t yet have an emergency fund? The answer is simple: start saving.
And what if you don’t have extra money and live paycheck to paycheck? The advice is the same, but the savings amount can be tiny, even symbolic—just to build the habit. For example, on the 1st of each month, set aside the smallest amount you can. Think of it this way: even with very low income, if you had saved just 50 dollars each month over the past 20 years, you’d now have 12,000 dollars. OK, maybe 50 dollars was too much, but even 10 dollars per month would have gotten you 2,400 dollars—not a huge sum, but potentially enough to cover an emergency like a broken washing machine.
However, there’s a problem—you guessed it: inflation.
Imagine this: you decide your rainy day fund needs to be 12,000 dollars. You save slowly and reach your goal by 2002. You’re happy—it’s there, ready to help in a crisis. But now it’s 2022, and that same emergency repair you planned for now costs 22,000 dollars. What happened? Inflation eroded the value of your savings. The number is the same, but its purchasing power has halved.
In short, your money lost around 3% of its value each year. Over 20 years, that adds up. In reality, you’ve lost nearly halfthe value of your fund.
So how do you solve this problem? Unfortunately, it’s very difficult, because we fall into a contradiction. One of the key features of a rainy day fund is that it must be liquid—you must be able to access it quickly, ideally immediately. That means it’s not wise to keep it somewhere you can’t get to easily. For example, if you lock it into a fixed-term deposit in a bank, there may be conditions and penalties for early withdrawal. If the answer to “Can I access it today?” is not yes, it’s not a good option.
Even if the money is in a savings account, the problem of inflation remains. What if your bank pays only 0.5% interest, but inflation is 5%, 8%, or more? You save a little, but not much—and at what cost? Every place where you can park your money involves a trade-off between interest rates and accessibility. High interest usually means lower access.
Some people invest their emergency fund in stocks or bonds, but that’s risky. What if you need the money on a bad day in the market? Can you afford to lose 10% or more of it instantly?
As mentioned, there’s no perfect solution. If this money wasn’t for emergencies, we could explore many options—but it is, and that changes everything. Ideally, you should be able to access the money within a few hours. Anything slower defeats the purpose of an emergency fund.
So even though inflation constantly eats away at your savings, the advice remains: start building your fund—if at all possible. It brings peace of mind, because trouble always comes eventually, no matter how much we hope it won’t—or believe it’ll skip us.
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