How Much Do I Need to Keep in My Emergency Fund?
July 21, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial
If the COVID-19 outbreak—and the fallout that has since ensued—has taught us anything, it’s that the world we live in is one that is truly unpredictable. Even if things seem to be going well and that sudden changes are unlikely to emerge, there are countless “surprises” that can quickly cause us to fall into a state of financial disarray. Because the only constant in our world, it seems, is unpredictability, it is important for everyone to have an emergency fund.
Emergency funds need to be liquid, meaning that you should be able to be accessed with very little notice. Generally, this means that—despite the fact your return on investment will be much lower—you will want to keep the funds in a savings account, a special checking account, or another account that allows immediate withdrawals or transfers.
Below, we will discuss some of the most important things to think about when creating your emergency fund. By preparing in advance, you’ll be in a much better position to address sudden financial challenges as they inevitably emerge.
Sizing Up Your Emergency Fund
As a general rule of thumb, your emergency fund should—ideally—be enough to cover 3-6 months’ worth of personal expenses. This includes your rent or mortgage, your car payments, utilities, and all other regularly occurring bills. The need for having an emergency fund will also vary depending on your personal situation. In a one income household, you may want to lean on the side of keeping more set aside because a sudden loss of employment will naturally have a greater impact on your family’s total income. Additionally, business owners will also want to save to cover business expenses in addition to the expenses they accrue at home.
When calculating your emergency needs, it will be crucial to account for how insured you are, as well. At a minimum, you want to put yourself in a situation where you will be able to cover the deductible for any car insurance, health insurance, or homeowner’s insurance claim you might need to file. If these deductibles are currently out of reach, you may want to consider restructuring your policies to lower your exposure (though your premiums will likely rise as a result).
Slow and Steady Wins the Race
If you are young or otherwise have very little savings, the idea of suddenly being able to set aside 3-6 months’ worth of expenses might initially seem impossible. But while it will indeed take some time to save this money up, you should not let the challenge of saving deter you from even trying. To the greatest extent you can, begin by setting aside 5-10 percent of each paycheck until you’ve reached your savings goal. In some cases, this might mean having to make some sacrifices, but the financial security you gain will still be worth it.
At the same time, it is also important to recognize that your emergency fund needs to be separate and distinct from other long-term savings projects. Suppose that you determine the amount you need for this fund is $20,000. This does not mean you should simply strive to have that amount of money in a retirement account, a college savings account, an account being used to save for a home, or any other account being used for a specific purpose. Your emergency savings should be reserved for emergencies only.
It is extremely unlikely that you will live your entire life without ever needing to dip into this particular fund—if, somehow, you manage to do so, your future self certainly still won’t regret having built a reliable safety net. While building an emergency fund may not be the most glamorous part of saving for the future, these funds have saved countless people from a variety of unpredictable circumstances.