Rule of Thumb? It Depends
If you’ve thought about an emergency fund or looked up information online, you’ve probably seen advice that suggests that you save three to six months of expenses. With any rule of thumb, that number depends on your particular situation. Accumulating three to six months of savings is not an insignificant amount, and it may seem pretty daunting. So what I recommend is to start small: begin with $1000 or $2,000 in savings, and then work your way up to $3000. This way, you reduce feeling overwhelmed and like it’s too big of a mountain to climb.
Why Have an Emergency Fund?
So why do you need an emergency fund? Sometimes life will leave us up the creek without a paddle. Therefore, it’s essential to have money set aside so that when the inevitable happens, you’re able to weather the storm in a way where you won’t react because you don’t have enough money to do what you want. For example, if your employer fires you from your job and you don’t have an emergency fund available, you may be forced to take the first job opportunity that comes up because you have to pay your bills. That job could be a terrible cultural fit, and it may not pay you enough money or what you’re worth.
Another example where an emergency fund is would be helpful is if you’re in a terrible relationship and you need to leave immediately. Instead of staying in a horrible relationship, an emergency fund acts as an insurance policy that will allow you to start over without relying on a partner. So it’s imperative to have emergency funds when unexpected situations arise.
Calculating Your Emergency Needs
There are a couple of different ways to calculate what you need for your emergency fund. One way to determine your needs depends on what your expenses are right now. Another way to gauge what you require is to determine what you think your costs will be if you lose income. Calculating what your expenses are currently is more realistic than cutting costs because people overestimate how much they’re able to cut in the future. The most conservative place to start is to evaluate your current spending. Let’s say you spend $5,000 a month. If you want a three-month emergency fund, you need to save $15,000; if you’re going to save six months, you need $30,000. The amount you’re saving adds up quickly, but don’t get overwhelmed. Instead, break up your goals into manageable chunks.
How much you need to save will depend on a few factors. Do you need three, six or 12 months of expenses? Do you have a partner or spouse whose income you would be able to rely on if you lost your job or became unable to earn as much revenue? If so, that would increase the runway that you have available because you would be able to depend on their income. Do you have any income from a side hustle where if you were to lose your full-time job that you would have some other cash to rely upon?
You may plan on quitting your job and starting your own business. You might be looking to invest time in starting a business while reducing your hours at your current job. Either way, you will want a larger emergency fund because when there’s more uncertainty, there’s more risk, and you want to be able to cover that liability. When you start a business, you have to factor in not only whether you have enough startup funds to leap, but do you have enough money saved to invest in the company in the way that you want? Do you have enough capital to grow and sustain the business as you want?
Savings Order of Operations
Each person has different savings goals. For example, an emergency fund, paying off credit card debt, saving towards retirement or saving for an upcoming trip. But what if you’re trying to save for one or more at the same time? You can put a different percentage towards those different goals, such as half of the money you have to save towards an emergency fund and the other half towards credit card debt. However, if you have less than three months of expenses in your emergency fund, prioritize that. You can still save for both goals, but instead of splitting the savings 50/50, put an outsize portion towards the emergency fund because, again, if and when life throws you a curveball, you want to be prepared.
If you have any questions about how much money you should have in your emergency fund, let me know in the comments. I always appreciate hearing from you. And if you have any suggestions for future blog topics, just let me know as well.
This post was adapted from an episode of the Fireside Financials series. If you’d like to check out the video, you can watch it here!