How Much of an Emergency Fund Do I Need?

by Kevin on April 9, 2009

We’ve talked about the importance of a proper emergency fund several times in the past. But what if you don’t know how large your emergency fund should be?

This is an area of personal finance I personally struggled with for a while in the past. How much is enough? Do I have enough to realistically cover us during an emergency? Have I put too much aside in savings — money that I could be investing or paying off our mortgage with? I changed my target several times as we went along.

Let’s look at both ends of the spectrum — just barely enough and probably too much.

Discover the Minimum Emergency Fund Coverage You Need

Finding out exactly how much money you need in savings is very simple if you have a budget. This is yet another reason why every single person reading this should have a budget. The budget tells you where your money should go. It will tell you where it typically goes, too, if you aren’t good at sticking to the budget.

This may sound basic, but let’s look at it this way: if your budget is based on $2,500 and $1,900 of that spending is in fixed, recurring, non-negotiable expenses each month that  is your starting point.

Another way to look at the above is that $600 of your $2,500 monthly spending is negotiable. It is stuff you could potentially cut back on if you absolutely had to due to job loss or some other type of emergency. That $1,900 is the minimum emergency fund coverage you need to pay for just one month’s spending. This is what I would consider the bear minimum coverage you would need for your emergency fund. One month is really not a lengthy time period and you would need to recover your income very quickly to not burn through the entire emergency fund shortly.

Again, $1,900 is what you would absolutely need to make ends meet every month. In an emergency you are likely to cut back to this number. Since this is one month’s expenses you will simply multiply that number by how much months of emergency fund you would like to have saved up.

Do You Count Your Emergency Fund in Years Rather Than Months?

This is the polar opposite of having a tiny emergency fund. If you’re counting your emergency fund in more than one-year increments that might be too much. In fact I would say that unless you are super conservative having two or three years in emergency funds is way too much. However, you would probably rather be on this side of the fence than just having minimal emergency fund coverage. But you are likely missing out on higher returns for the funds if you were to use them elsewhere.

Let’s go back to the original example of $2,500 spending with $1,900 being relatively fixed expenses. If you have two years of expenses saved up you are looking at $45,600 (24 months x $1,900). Sounds like a lot of money to me.

If at the same time of having this huge emergency fund you still had consumer debt or a mortgage you are missing out on lowering your interest paid. You could be missing out on investing that money which in the last year may have been a good thing. But not every year is like last year in the investing world.

Maybe you are really conservative, but I think two years is a tad bit too much.

How Much Emergency Fund is Necessary?

The typical rule of thumb is three to six months of expenses. But I would challenge you to not rely on a rule of thumb alone. Your personal situation is more important than the rule of thumb.

Emergency Fund for Singles

For singles you have no one else to rely on but yourself. Three months might not be enough coverage for you especially in a tough economy. Perhaps six months should be your first goal and then over time grow that to twelve months due to the higher risk of losing that one income.

Emergency Fund for Married with One Income

This is essentially like being single. If you are a one income family, you probably have kids. Three months is definitely not enough of an emergency fund for you. Again I would target 6 to 12 months for your emergency fund.

Emergency Fund for Married with Two Incomes

When you are married and have two incomes you have a bit more of a cushion against financial disasters. It is highly unlikely that both individuals will lose their income at the same time. So that $1,900 minimum expenses you have might be covered by just having one income. You live, save, and invest on the other income. In fact I discovered a while back that our emergency fund was larger than we thought.

In this case 3 months isn’t a bad target to go after. Of course the more the merrier, right? So don’t stop once you hit three months. Just breathe a little more easily and go on with life.

Adjust Your Emergency Fund Calculation Periodically

The last thing I want to mention is you will need to recalculate your bare minimum expenses periodically. One year it might be $1,900. The next year it could be $2,200 due to rising costs or life changes. You don’t want to find yourself in a situation where you think you have six months of funds saved up, but in reality it is now only two months of expenses. Not a good place to be. Check your budget annually or semi-annually to make sure you are still on track.

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