An emergency fund is basically a pile of money that is used for unexpected expenses such as car repairs, medical costs, or natural disasters. We all will have at least one unexpected expense in our lives so we need to have funds available to mitigate it. An emergency fund can be comprised of short and long term savings that are intended for standard large purchases (house, car, boat, etc..).
There is no universal recommendation for how much to have in an emergency fund. Nearly every finance book has its own recommendation. Many suggest arbitrary amounts without taking into account an individual's situation. The fact is, everyone's situation is unique and living expenses vary greatly. There are three key factors to decide how much to save:
(1) What are your monthly necessary expenses?
(2) What does your household income stream look like?
(3) In your city, how much demand is there for your profession?
The first rule of thumb to consider is based on necessary expenses. Add up what you spend on housing, utilities, transportation, and food in a month to determine a good number for your necessary expenses. The second rule to consider is your household income stream. If, during a normal month, you can live off of one spouse's income or you have an alternate income source besides your primary job, a three month emergency fund (three times your monthly necessary expense amount) is probably sufficient. If your primary job is the only source of income, having 9-12 months saved for an emergency fund (nine times or twelve times your necessary expenses) is a safer bet. Your economic geography can tweak these amounts somewhat, which is where rule three comes into play. If you live in an area where your skills are in higher demand and there are multiple industries you could work in (e.g. getting unsolicited messages from recruiters on at least a monthly basis) having a smaller emergency fund may be workable (though not advised). On the flip side of industry demand, if you currently work for the only available game in town, the minimum safety net I recommend is 12 months of necessary expenses. For instance, in my experience, it takes at least 3 months from job application to first pay check (I work in an "in demand" industry: engineering), so 3 months' necessary expenses is the bare minimum to have in an emergency fund.
Traditionally, you want to maintain a $2,000 cushion In your checking account for any immediate emergencies (things that need to be paid same day) or to avoid accidental overdrafts. Next, 3 months of necessary expenses should be kept in a savings account (preferably an interest earning money market account). Lastly, the remainder emergency funds (3-9 months of necessary expenses) should be kept in a CD (certificate of deposit) ladder. If you're not familiar with CD ladders you can view a step by step guide here. Technically 12 months of necessary expenses is all an emergency fund needs to be. Putting any other money into higher yield investments is wise because almost all investments are only accessible after 12 months. At the time of this writing interest rates are so low that the "traditional" banking methods, while generally low maintenance and FDIC Insured, give pretty poor returns. A more lucrative, but more intensive, method would be to place your emergency fund (the amount above the $2,000 cushion) into "non-traditional" banking methods. These methods include high yield checking accounts (FDIC insured), Municipal bonds (tax free), or (if your income level allows) making contributions to a ROTH IRA (tax free growth). Additionally, if you have a credit card with a high credit limit you can probably move most of your $2,000 cash cushion from your checking account into investments.
Emergencies in life are unpredictable. Being in one doesn't need to be compounded by a financial crisis - having a sound savings strategy helps you to be prepared.