What Is a Realistic Amount for Emergency Savings?
Chances are that if you’ve ever looked into how much money you should be putting away as an emergency/”rainy day” fund, you have found that most financial experts, including myself, will suggest something like three to six months’ worth. The question, though, is three to six months’ worth of what? Gross income? Net income? All household expenses?
Here’s my take on this vital subject. First of all, it is my opinion that having an emergency fund is one of the top two or three indicators as to whether a household will remain financially stable or remain living continually on the edge of a financial abyss.
Next, I differ from many professionals who advocate paying down credit card debts and establishing a retirement fund before ever working on an emergency savings strategy. When asked which of the three should be the priority (emergency fund, credit card debt repayment, or retirement funds), my answer is always the same: “yes – to all three.”
From my experience, emergency savings is an attitude that leads to action, so committing to saving regularly, even in small amounts initially, is more important than trying to figure out long-term amounts. Perhaps, an initial savings goals could just be having $1,000 in a savings account within a reasonable time (perhaps 6 months or a year). If you can achieve this, you’ll already be ahead of 85% or more of the general US population.
3 Things to Consider When Setting an Emergency Savings Goal
That said, to establish a truly effective emergency spending strategy, each household needs to look at their current income sources (usually some type of employment) and ask themselves, “If I were to lose my job today, how long would it take for me to find another job that will earn me/us about the same income?”
A recruiting specialist once shared her rule of thumb with me that I think works in many situations: For every $10,000 of annual income you receive from your current employment, it will likely take you a month to find a replacement position. That means that if you earn $30,000 a year, it will take you on average 3 months to find another job.
However, during an economic downturn, it would be safe perhaps to double that estimate. So $30,000 of annual income might take 6 months to replace.
What to Include in Your Emergency Savings Fund
Next, now that you have an idea of how many months you might be without income, multiply those months by the amount of money you would need not only to survive but also to be at least minimally comfortable.
List #1: Include expenses such as rent/mortgage, vehicle-related costs, food, basic clothing, utilities, holiday and birthday gift giving, and any contracted services with penalties for early cancellation.
List #2: Do not include expenses related to vacations and travel, dining out, external entertainment (think theater, cinema, clubs, concerts, etc.), back-to-school shopping, charitable giving, etc.
If you ever lose your employment (or if you have a major medical event), your household should go into financial lockdown immediately, cutting out all expenses under List #2 above while planning for those under List #1. Unfortunately, we all tend to be far too optimistic about our ability to find re-employment soon, leading many to continue to spend at current levels even though we no longer have a steady income. Of course, even if you do qualify for unemployment income (for which many do not because of the circumstances leading to their job loss), it only replaces a small percentage of your monthly income.
In summary, if you earn $40,000 per year and have monthly expenses (under #1 above) of $1,800, you’ll want approximately $7,200 available to you in case of job loss (4 months x $1,800 = $7,200).
Where to Put Your Emergency Savings
After calculating this figure, it’s only natural you might wonder, “where am I suppose to put all that money?” Should you put it all in the common savings account, earning .25% interest? I would hope not. You want to earn as much interest as possible while also keeping the cash in a fairly easily accessible account (“liquid”). One possibility would be to work toward having four 4-month Certificates of Deposit of $1,800 each, with one maturing each month. Money Market accounts may also work as emergency savings vehicles.
When to Use an Emergency Savings Fund
I’m willing to bet the majority of us know the line between what is and what isn’t an emergency. However, up to this point, I have only mentioned the one instance of job loss. Here’s a list of other times when your emergency savings will come in handy:
- Major Home Repairs: On a case by case basis you can decide whether whatever is broken needs to be fixed immediately. Among the worst home disasters are bursting pipes, non-functioning furnaces or plumbing, broken appliances, and leaky roofs.
- Car Repairs: Many small car repairs can be handled out of your monthly budgets. However, if you need to replace a dead transmission or have to pay for a multitude of repairs after an accident, your emergency savings fund can come to the rescue.
- Medical Bills: Even less predictable than the first two, health issues and treatment can certainly leave a long-term impact on your finances, unless you have an emergency savings to rely on.
- Loss of Spouse: Whether or not this includes the loss of income, it certainly will affect the surviving spouse’s financial life for years to come. An emergency savings fund can provide a buffer during this time of transition.
An emergency savings fund is truly an opportunity to ensure your peace of mind no matter what life has in store. For tips on how to build an emergency savings fund, check out our blog “How to Save Money” for the next steps.
Best wishes in developing and implementing your emergency savings strategy. It will take time and effort, but in the end, it will definitely be worth it.
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