You already know you should have one, but how much should you be saving in an emergency fund? Is there a right amount?
You’ll often hear from experts that you should set aside 3 to 6 months of basic living expenses in your emergency fund. But we all live different lifestyles and our incomes vary. How do you figure out the right amount to save?
In this article, we’ll discuss important considerations in determining the size of your emergency fund, cover the reasons why you should have one, and share our emergency fund calculator to help you find out the amount you need to save.
What is the right emergency fund amount?
When it comes to figuring the size of your emergency fund, the answer will depend on the stability of your job and your lifestyle. Age also plays a factor. As you get older, it can take longer to find a job that fits your skill set.
But perhaps one of the most important considerations in determining how much you should be saving in an emergency fund is the time it takes you to find a new job.
Pre-pandemic information from the Bureau of Labor Statistics, indicates that about 65% of unemployed people looking for work were able to find a new job in about 3 months or less. The rest took 3 to 6 months or more.
So it’s reasonable to save an emergency fund amount that covers at least 3 months of living expenses. But should you have more?
A 3-month emergency fund as your baseline
If you work in an industry where jobs aren’t too difficult to come by, your fund should cover at a minimum about 3 months of basic living expenses. These expenses should include your:
- Car payment
For example, if you need $2,500 to cover the above expenses for a given month, then you should have $7,500 in your emergency fund. Note that discretionary expenses aren’t included, as these would be the first ones you would cut out from your budget should the need arise. These would include items such as:
But a 6-month fund is better
If your job is in an unstable industry or where jobs are more difficult to come by, you should consider having an emergency fund that covers 6 months of living expenses.
A larger cushion is also preferable when you have dependents or when you’re uncertain you’ll be able to replace lost income within a 3 month timeframe.
A 12-month fund is difficult, but worth it
Building a 12 month emergency fund may not be possible if your earnings are modest. But if you’re part of a double income household or are a high earner, consider one.
Knowing you have enough money to tide you over during your next job search can give you peace of mind. Especially when your job is unstable, and you have a family to take care of.
» Related: How to Save For And Build an Emergency Fund
What are the top reasons to have an emergency fund?
The motivation to have an emergency fund goes beyond supplementing lost income due to a job loss. In a addition to helping you cover living expenses, your fund can help you with the following as well:
Provides a cushion to cover unexpected expenses
Having emergency savings can help you face those financial curveballs that life will invariably throw your way, including the loss of a job. They can consist of things such as:
- Unexpected medical expenses and medication
- Major car repairs and maintenance
- Financial hardship by a close family member
- Unexpected back taxes
- Pet illness and related expenses
- Home repairs including a broken HVAC or appliance
- Unexpected travel or relocation
- Pay for unexpected attorney’s fees
Helps you avoid going into debt
Having a well-funded emergency fund can help you avoid expensive credit card debt if you’re facing unexpected bills.
When you save for an emergency, the money you set aside goes entirely into your fund. So every dollar you save is a dollar you can use to pay for emergencies.
But if your rainy day fund is inadequate and you end up having to use a credit card, you’ll end up paying the amount you put on the credit card plus incurred interest, which can be steep.
And once you incur credit card debt, paying it back can be tough because it grows quickly. It can trap you financially.
» Related: 7 Crucial Steps to Get Out of Credit Card Debt.
Prevents tapping retirement funds
It can be tempting to use retirement funds such as an IRA as an emergency fund. But making early withdrawals carries important tax implications and penalties.
With an IRA, you’ll need to pay ordinary income taxes on the amount you withdraw. Not only that, but if you’re under 59 ½, you’ll have to pay a 10% early withdrawal tax.
These are all unnecessary additional expenses that you can avoid with a solid emergency fund.
Provides peace of mind
Avoiding stress over money is another advantage of having a well-stocked emergency fund. Money stress can affect your relationships and impact your mental health.
Stress is a response that’s deeply ingrained in our brains, so it’s impossible to eliminate it completely when the unexpected happens. But having a healthy amount of emergency savings can boost your inner balance and help you focus on fixing your financial situation faster.
Serves as an opportunity fund
Having an emergency fund can help you take advantage of investment opportunities when others can’t. In the right circumstances, your emergency fund can also function as an “opportunity fund.”
For example, if you’re in the midst of a recession, but your job remains relatively secure, this additional liquidity puts you in a good position to take advantage of depressed asset prices. You can buy when others are more desperate to sell, improving your long term returns.
Emergency fund calculator
The image below depicts Walletero’s simple emergency fund calculator. It’s easy to use. Start by entering each of your basic monthly expenses on the left hand side. The items you can change are all highlighted in blue.
The math is done in the background to calculate how much you should be setting aside. The calculator gives you the amounts necessary for a 3, 6 and 12 month fund.
If you’ve already started saving money for emergencies, input the amount you have on the right hand side of the calculator.
You can use this link to open our Emergency Fund Calculator.
Where should you keep your emergency fund?
The cash in your emergency fund needs to be available at a moment’s notice. So liquidity and availability are top considerations when looking for a place to keep your emergency savings. In that sense, an online high yield savings account is perhaps an optimal place to keep your funds.
Online banks are able to offer a higher APY since they don’t run the same costs as brick-and-mortar banks do. Also, you can make unlimited deposits and access your money with the same frequency as a typical savings account.
Hopefully this article has helped clarify how much you should be saving in your emergency fund. While the recommendation is to set aside 3 to 6 months worth of expenses, maybe you find that saving for just one month’s worth is challenging enough.
Don’t panic. What’s important is that you get started. Saving money consistently is the key to reaching your goal. And our Emergency Fund Calculator can make it easier to come up with your target amount.
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