How Much Money Do You Really Need in Your Emergency Fund?
While most financial experts agree that you should set aside three to six months of cash for emergencies, this advice can be quite broad, especially for such a large amount of money. Here’s a look at the basic device costs that should be included in your emergency fund, and how to know if you should aim for just three months, six months, or even more.
What is an emergency fund?
An emergency fund is a cash reserve that will cover financial emergencies such as job loss, unexpected medical bills, or car repairs. Unlike higher risk investments such as IRAs or 401 (k) s, the emergency fund can be withdrawn promptly without any penalties or fees. It is usually a good idea to set up your emergency fund before investing, however if you are struggling to deal with high interest debt (above 10% per annum), you need to pay it off first.
How to calculate your emergency fund
Experts recommend deferring expenses by three to six months. If you live paycheck to paycheck, this might sound like a joke, but it can help you focus on shorter-term goals and then restock emergency supplies as you go. For example, you can start with a three-month goal by recording the total monthly expenses you need to pay :
- Accommodation / rent
- Health insurance
Expenses that you would not include (at least not yet) will include “decent” monthly expenses, as shown below:
- Entertainment (including streaming subscription)
- Other savings
To help you summarize your expenses, consider using this emergency calculator provided by Fool.com. That being said, you might be surprised at some hidden costs that can be funneled into an emergency fund, such as a subscription service you barely use or money spent on dining out at a restaurant. In any case, the goal is to accumulate a portion of your savings intended to replenish your emergency reserves.
There is no consensus on how quickly you should build up your emergency supply, but since it is in general for emergencies, the sooner you do it the better (a reasonable goal would at least one month of expenses during the year). If you’re starting from scratch, consider saving $ 1,000 as an achievable starting goal (only 40% of Americans have saved enough money to cover the $ 1,000 unexpected expenses).
Consider the 3/6/9 rule
Since spending ranges from three to six months is a wide range, you can also consider the 3/6/9 rule to figure out how much you should save in your emergency fund:
- Save three months on expenses if: you have a reliable job, a stable salary, minimal debt and live alone without a mortgage or dependents. You can do without the help of a much smaller emergency fund if you always have the option to live with your parents as a last resort.
- Save six months on expenses if: you have children and have large debts such as mortgages or student loans. With dependents, you will need an extra pillow.
- Save nine months on expenses if: You have a precarious job or receive irregular income, such as contract or freelance work. If you have children and are the sole breadwinner in the family, ideally you should have a fund that covers the costs for nine months.
Where to store emergency supplies?
The most important thing you will need in a financial emergency fund is liquidity – the ability to quickly access these funds without penalties or fees. This is why you should hide this money in a savings, checking or cash account rather than keeping it in an investment like an IRA. This Lifehacker post will walk you through the options .