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Is Your Emergency Savings Fund Big Enough?

Steve Pomeranz, Emergency Savings Fund

How Much Money Should Go Into Your Emergency Savings Fund?

Setting up a rainy-day fund for lost income and unpredictable emergencies is a concept that most of us get on the face of it but which remains rather vague in practice.  Not only that, but a disturbingly large number neglect to follow through on setting aside enough money—whether it’s from not knowing how much they ought to reserve or because they find it difficult to make the necessary sacrifice to fund it.  If you fall into one of these camps, I’ll help you today by walking you through some of the considerations that go into defining how much you should save for your emergency fund, how to meet your target goal, and then separate that money away from your spending budget.  Before we begin, let’s get one kind of obvious thing out of the way that applies to everyone: credit cards are never a good substitute for an emergency fund!

Emergency Funds For Workers

One of the first factors you need to look at is whether you are currently earning a paycheck or living primarily on savings.  If you’re employed, you can probably get away with the minimum recommendation of most financial planners of putting aside three months of your current salary or six months if you are a freelancer or work in a cyclical industry.  This is to cover basic items in your household budget: housing, food, utilities, bills, and so on.  Even if you are eligible for unemployment benefits, it’s smart to put cash towards an emergency fund; there’s no such thing as being too prepared for whatever eventualities might come up.

Emergency Funds For Retirees

If you’re retired and living on withdrawals from your retirement savings accounts, perhaps supplemented by social security, you are going to want to save a much larger amount—enough to cover 1 to 2 years of spending so you don’t have to withdraw from your long-term savings.  The main reason for the larger size of this fund is that you don’t want to be forced to sell off assets from your retirement accounts at the same time you encounter a bad market.  This number should reflect the amount you’re spending minus social security and any other income sources. This might seem like a pretty big hill to climb, which is why you need to be socking money away during as many of your working years as possible. Even if you’re a disciplined saver peeling off savings from your paycheck, it will take several years to build up two year’s-worth of income. You can add to this savings by keeping some of your investments in short-term bonds and cash.

Covering Monthly Expenses Requires Adding Them All Up

If you’re uncertain what your monthly expenses really are, there are lots of online budget calculators and, most likely, tools from your bank that can help.  Certain items might be “amortized” to a monthly average.  For example, if you spend $1,000/year on clothes, you’d want to add 1/12th of it (83.33) to your monthly budget instead of ignoring that spending just because it occurs erratically.   Naturally, this also applies to restaurant, entertainment, travel costs, gift giving, and other categories of spending you’re accustomed to.  A side benefit to thinking about this stuff and writing it down in a monthly budget is that you might find some areas where you can cut back.

Unsteady Income?  Set Aside More Money

Assuming you’re still working, the follow-up question to ask yourself is: How consistent is my income?  If you’re a freelancer, or work in the so-called “gig economy” where you’re pulling in income from many different sources or you’re in a business that goes through regular cycles of expansion and contraction (meaning your hours fluctuate a lot over a period of months or years), you’ll want to set aside more money in your emergency fund.  It’s critical to avoid withdrawing money from your retirement accounts if you face a period of unemployment. First off, you’re essentially robbing from your own future. It’s within the realm of possibility that $10,000 taken out today will cost you $100,000 in lost savings many decades down the road.  Secondly, something that you never hear people talking about is if you work in a cyclical industry and are laid off, it is possible the stock market won’t be doing too well either so you might be forced to withdraw retirement savings at the very worst time—just when the market was selling at a low value.

On a more positive note, if you are part of a dual income family, you can get away with a smaller emergency fund because it’s unlikely that you and your partner will both find yourselves unemployed at the same time.  Of course, this doesn’t apply if you’re both freelancers or work at the same company that’s going through a big round of layoffs.

Financial Emergencies

So far we’ve just talked about emergency funds as a replacement for lost income to cover consistent expenses.  A more precise budget would include amounts for unexpected major expenses like a sudden medical bill, expensive car repairs or a family emergency that requires travel and hotel costs.  Determine a kind of ballpark figure for how much one of the scenarios might cost and add that to your income replacement figure.

Making Your Emergency Fund Goals A Reality

So, how quickly do you need to build up your emergency reserves?  The short answer: as fast as you can. 20% of your paycheck is a good target to shoot for.  Granted, this is quite a large amount.  If you can’t get there or can only reserve that much every so often, anything is obviously better than nothing, but try to use 20% as a benchmark. You will be delightfully surprised at how fast the money accumulates into something you can be proud of, not to mention the peace of mind you’ll feel having attained some financial and emotional security.

There is, however, one key caveat to all I have said here today. Don’t start saving until you pay down your expensive debts first!  And the caveat to this caveat: Don’t include your mortgage debt in this pay-down equation unless, for some reason, you’re paying mortgage interest of 7% in a market where the average is around 4%.

Another necessary detail on the pragmatic side of all this is making sure to segregate your emergency cash from your regular checking and savings accounts.  Always set up a separate deposit account for your emergency fund.

Is there such a thing as an emergency fund that is too big?  Yes, if you exceed the guidelines I’ve laid out here by multiple thousands of dollars, perhaps that money ought to be moved over to your long-term investing and savings accounts. You don’t want too much money sitting around earning practically nothing, right?

So, one more thing I want to state again: Even if you never have to draw-down on your emergency fund, you will be rewarded for your hard work in the form of emotional security and the knowledge that you are truly on the road to financial independence.

Attaining this level of money maturity will have a very powerful and positive influence on the quality of life you will lead.

Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing piece to make decisions. The information contained herein is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice.  Please contact your financial advisor with questions about your specific needs and circumstances.  There are no investment strategies, including diversification, that guarantee a profit or protect against loss. Past performance doesn’t guarantee future results. Equity investing involves market risk, including possible loss of principal.  All data quoted in this piece is for informational purposes only, and author does not warrant the accuracy, completeness, timeliness, or any other characteristic of the data. All data are driven from publicly available information and has not been independently verified by the author.

I've been an investment strategist and adviser for over 35 years, leading with a mission of unbiased advice to educate and protect listeners on my weekly radio show on NPR affiliates nationwide. I have been named a “Top 100 Wealth Advisor” by Worth Magazine and “Top Advisor” by Reuters.