Building an emergency fund is one of the most important financial steps we need to take, especially in today’s shaky economy. The big question for many of us, though, is how much is enough? Conventional advice says we should set aside three to six months’ worth of expenses, but that one-size-fits-all rule might not be appropriate. Let’s look at how to find the right number for your situation.
Find out now: How much do I need to save for retirement?
Why Is It So Hard?
Part of the trouble with determining how much you should save for emergencies is that it’s impossible to know beforehand just how big or small one of those emergencies will be. Unexpected car repairs can cost anywhere from a couple of hundred dollars to $3,000, while a major medical emergency could be financially devastating.
If you lose your job, it could take a while to find a new one. As of January 2016, the average length of unemployment is 28.9 weeks. And then there’s the possibility of all these misfortunes happening at once, or before you get a chance to replenish your emergency reserve.
Even the financial gurus don’t agree on a single magic number for your safety net. Radio host Dave Ramsey says to start with $1,000 in a “baby emergency fund” and then aim for a fully funded account with three to six months of expenses, while Finish Rich author David Bach recommends at least three months’ worth, and Suze Orman advises at least eight months’ worth. That’s a pretty wide range!
Related Article: 6 Best Places to Park Your Emergency Fund
Figure Out Your Emergency Fund Needs
Everyone has a different opinion on the ideal emergency fund, so the best thing you can do is sit down and look at your personal situation. Rather than just take the monthly expenses you have now and multiplying by a number of months, you’ll need to get a more realistic picture of your likely income and expenses during a financial emergency:
1. First, write down your necessary expenses for one month: rent/mortgage, transportation/auto costs, insurance, groceries, utilities, child care, other bills and debt payments.
2. Consider anything you can get rid of or put on hold – things like cable service or dry cleaning – and subtract those from your bills.
3. Don’t forget any irregular but necessary expenses, like property tax payments, as well as any possible new expenses, such as health insurance premiums if you lose your coverage.
4. Now subtract from your expenses any reliable sources of income, such as child support, unemployment insurance or regular side income. If you have a dual-income household, you can take your partner’s income into account (but that can be risky, too).
Now that you have an adjusted monthly expenses amount, it’s time to figure out how many months to shoot for. It might be three months or a whole year, depending on your own personal values and living situation.
If you’re a single professional with few expenses and a high-demand job, you may feel safe with just a few months. If you’re a parent and the sole breadwinner, a year would be more appropriate. If you have no medical insurance, poor health or an insecure job, aim for more.
You get the picture. Decide how many months would make you feel “safe” in the worst possible scenario.
One other consideration is if you have a lot of high-interest debt. In that case, you might aim for just one month’s worth of expenses and then tackle your expensive debt before continuing to save. It’s always a good idea to have a plan so that you know which debt to pay off first.
The most important thing is to get started and continue saving. Automatic monthly transfers to your savings account can help you stay on track.
Personal finances are just that – personal. So it’s best to do what works for you, and remember to reevaluate your savings plan regularly, because emergency funds are a moving target.
Photo credit: ©iStock.com/Wavebreakmedia