How Much Do You Need in Your Emergency Fund?

In my first post on emergency funds, I discussed why having an emergency fund is a wise idea. The next question is, how big does an emergency fund need to be?

The question of how much should be set aside for emergencies is one of several that people tend to avoid.  It can be avoided either by not saving anything, or by saving much more than is needed.  I’ve seen clients do both, although the former is the more common error.  Most people want to think about an emergency fund about as much as they want to think about a root canal operation.

I’ll reiterate what I said before:  An emergency fund is like an insurance policy.  You hope that you won’t need it, but if you do need it, you really want it to be there for you.  There are a variety of factors that need to be considered in determining how big an emergency fund should be:

  • Amount of your regular monthly expenses
  • This is your starting point; the size of your fund should be determined relative to this number.  This is what you spend (by choice), not what you make; it doesn’t include the chunk eaten by income or payroll taxes, the amount you save for retirement, etc.

  • Variability of your monthly expenses – are your expenses variable or stable?
  • For households with stable circumstances, i.e. not in the process of starting up a business or otherwise in the midst of a major transition, the ballpark number for an emergency fund is three to six months in living expenses.  If you have a reasonable expectation of some large expenses that must be paid, you might even need to go higher.

  • The proportion of your expenses that are not discretionary
  • If you have expenses that you could choose to eliminate – like being able to eliminate the cost of your rent by moving in with relatives – you might not need to save as much; you have other resources.  If you have a home mortgage, a HELOC payment, a vacation home mortgage, a boat payment, and a kid starting college – you have a lot of expenses that aren’t going away quietly.  You need to be more conservative in your fund target.

  • Degree of demand for your skills – how long would it take to find a job if you lost yours?
  • Did it take a long time to find the job you have now?  Unless the job market has changed since that time, that gives you an idea of what you might expect if you lost your job and had to find a new one.  If jobs in your field are really hard to find, you may need to steer your target north of six months’ expenses.  If you have a job that would require relocating in the event of a layoff, for example, that might justify boosting the fund by the cost of relocation unless you work in a field in which relocation packages are common for new hires.

  • Availability of financial support from relatives
  • You may think your relatives can help you when really they aren’t able to.  But if you have a high level of confidence that they’re willing and able to help in a crisis and you’re willing to receive their help, your reserves don’t need to be as large.

  • Stability of your income
  • Do you work in a cyclical industry?  If so, you have a greater chance of needing to tap your emergency cushion due to a layoff than, say, a tenured college professor or an undertaker.

  • Availability of more than one source of income
  • For a one-income household, it makes sense to lean towards the six-month savings level as a goal.  For a two-income family, targeting the lower end of the range could be okay – the probability that both wage earners would lose their jobs simultaneously is low, assuming that they work for different employers.  However, if one wage earner makes a lot more than the other and you’re living on both paychecks, you need to target a higher savings goal, in case the high-wage job is the one that’s lost.

Although you could be out of work for much more than six months, it would normally be considered excessive to keep more than six months’ expenses in an emergency fund.  Even so, if you’re in a situation in which a layoff seems imminent, that would be a good reason to cut back your spending and bulk up your emergency fund beyond the six-month limit.  As noted in my previous post, there are many reasons other than a job loss that could force you to draw on an emergency fund.  The reason that the number is usually scaled in terms of months of spending is that the magnitude of an emergency expense often is proportionate to the cost of your lifestyle.  A valve job for a Jaguar costs a lot more (so I’m told) than one for a Chevy.

The “right” amount to have in your emergency fund goal is quite specific to your household’s circumstances, and there is no single “right” answer.

One final, important point: if you’re in the midst of paying off credit card debt at high interest rates, you should not be saving for an emergency fund.  Pay the credit cards off first; then address the need for an emergency fund.

The next question I plan to address in this series is how an emergency fund should be invested.

About the author

Thomas Fisher, CFP®

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