How Big Should My Emergency Fund Be?
This is a common question in the personal finance community. Along the Path to Wealth, you start saving for retirement, pay off debt, and build an Emergency Fund. These crucial steps help build a strong financial base for you and your family.
But when it comes time to build an Emergency Fund, how big should yours be?
What Is An Emergency Fund?
An emergency fund is liquid money that you save up to help you in case of an emergency.
Liquid means it can be accessed within 2-3 days or preferably minutes.
This money is available to use in case of an unexpected job loss, natural disaster, medical emergency, or other events that you had no way of knowing would happen.
Ideally, your emergency fund monies will just sit and grow, ready to help.
What An Emergency Fund Is NOT
While everyone manages their money differently, I think it is important to remember that your emergency fund should not be used for Expected Expenses, they should be separate accounts.
Regular car maintenance, vacation money, annual insurance or registration payments, and new car or house down payments should all be pre-planned for in an Expected Expenses account. These are costs you know are coming and should save for regularly, separate from your Emergency Fund.
If you want to keep your emergency funds and expected expenses in the same bank account, make sure to keep track of what money is for what or use the “buckets” feature at banks like Ally.
Where Should You Keep Your Emergency Fund?
Because your Emergency Fund should be liquid, one of the best places to keep it is usually a High Yield Saving Account (HYSA). An HYSA is simply a savings account, often held with an online bank like Ally or CIT Bank, that offers higher interest rates than brick-and-mortar banks in your neighborhood.
An HYSA allows your money to be quickly accessible while still earning some interest.
Other options for keeping your Emergency Funds are Certificates of Deposit (CDs) or possibly short-term Treasury Bonds. Both of these may offer slightly higher interest rates in exchange for keeping your money for a certain amount of time. This maturity date may be good for people who have a hard time not spending available funds because they add an extra step in order to access the money and may have minimal fees for withdrawing before the maturity date.
Where Your Should NOT Keep Your Emergency Fund
An Emergency Fund should be stable, liquid money that you know is available and accessible in an emergency. Therefore, there are a few places you should not keep your emergency fund:
- Stocks- stock values go up and down on a daily basis. You do not want your emergency fund to be cut in half due to a bad market when you need it most
- Real Estate- real estate is an incredibly illiquid asset. It requires a whole process to sell a home and get money out of it. Some people depend on their HELOC as an emergency fund. This is a possibility but unless you plan to sell your house for a good profit right away, you’re just saddling yourself with more debt in your emergency.
- Private REITs, Syndicates, Art, Wine, Baseball Cards- Anything that requires you to keep your money invested for a required time and/or needs to be sold in order to get money out of it.
Emergency Funds are not the place to look for extraordinary growth or interest. It should be safe money that will be there when you need it. By keeping it in an HYSA, your dollars may not keep up with inflation over the long run but that’s a small price to pay for knowing the money is there in an emergency.
How Much Should You Keep in Your Emergency Fund?
The simplest way to figure out how big your Emergency Fund should be is to first figure out how much your regular monthly expenses are.
Go over your most recent bank statements and find out how much you spend in an average month:
- Rent/Mortgage
- Utilities
- Groceries
- Gas
- Insurance
- Medical Expenses
- Tuition or Childcare
- Etc.
Add it all up, and don’t forget to include your major Expected Expenses contributions. This is your monthly living expenses.
Most money gurus recommend having anywhere from 3-12 months of living, but how much should YOU have?
While personal finance is personal and everyone’s situation is different, I came up with a quick quiz to help guide you in deciding how big your Emergency Fund should be:
How Many Months Worth of Expenses Do You Need in Your Emergency Fund? Quiz
Answer YES or NO
________ If you were to lose your job, do you have a working spouse (in a different company/industry) that could cover the majority of your monthly household expenses on their check alone?
________ Do you have another family member (maybe a parent) who is willing and able to help cover your household expenses for an extended period of time?
________ If you were to be fired tomorrow, could you easily have an equal-paying job by next month?
________ Are you and your family members, free from any medical issues that could stop you from working for any period of time?
________ Do you have short-term disability insurance that will cover your pay in the case of a temporary disability?
________ Do you have passive income from investments, rental properties, royalties, etc. that could cover the majority of your monthly expenses?
________ Do you have a side hustle or other part-time job that you could easily increase hours to cover the majority of your expenses?
The more YES responses you have, the smaller the emergency fund you need.
The more NO responses you have, the larger your emergency fund should be.
With 3 or more YES answers, you should be fine with a 3-month emergency fund.
If less than 3 YES responses, you should probably keep closer to 6 months of emergency funds.
If you answered mostly NO, you might want to try to keep an emergency fund of up to 6-12 months.
Wrap-Up
It is completely up to you as to how large or small your emergency fund should be. If you prefer having more security, go ahead and make it larger than indicated in the above quiz.
If you are comfortable making extreme life changes, if needed, (lower paying job, drastically cut expenses, etc.) you can keep a smaller emergency fund.
Or if you have access to large amounts of money that just may take a bit longer to get to, like those mentioned in the “Where Your Should NOT Keep Your Emergency Fund” section, you may feel confident keeping just enough money in your emergency fund to get you through until those other funds are available.
Personal Finance is personal. Take a hard look at your finances. Discuss your thoughts with your partner/spouse or a trusted family member, friend, or coach. Decide what amount is right for you.
What do you think? How much do you keep in your Emergency Fund and why? Leave a comment below to join the conversation.
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