As you well know, life can throw you unexpected curveballs at any moment, be it a sudden medical expense, a job loss, or, say, a global pandemic. Given that, and that trying to get an emergency loan is typically not the best idea, having an emergency fund is essential. But that begs the question: How much is enough? Let’s find out.
Assess your monthly expenses
The first step in determining the proper size for your emergency fund is to assess your monthly budget. How much do you need to cover basic living costs if your income suddenly dries up? This includes housing, utilities, groceries, transportation, insurance, and other non-negotiable expenses.
Experts say that a good rule of thumb is to aim for an emergency fund that covers three to six months’ worth of essential expenses. In order to get an accurate picture, you need to tally up all of these must-pay bills.
You may also want to consider any recurring but infrequent expenses, such as quarterly insurance payments or annual subscriptions. This baseline amount will help you figure out how much you need to set aside.
Factor in your job security
Your job security should also influence the size of your emergency fund. If you work in a volatile industry or have a less stable source of income, like freelance work or a commission-based job, for example, you may want to save more than six months’ worth of expenses to cover potential dry spells.
Conversely, if your job is stable and you have little risk of sudden unemployment, you may feel comfortable with a smaller three-month emergency fund.
Consider your dependents
If you have dependents — children, a partner who does not work, or maybe aging parents — you need to factor their potential upcoming needs in as well when building an emergency fund. Are there medical or education costs that could arise? In addition, not only does more dependents typically mean higher expenses to account for, but it also means there are more possible unexpected events that can occur.
Account for insurance and other financial safety nets
Insurance is another key consideration. If you have robust health, home, auto, and/or disability insurance, you may not need as large of an emergency fund since your policies may cover the emergency. On the other hand, if you have minimal coverage or high deductibles, you should plan for higher out-of-pocket costs.
In addition, other safety nets, like a partner’s income, investments, or access to a line of credit, can reduce the need for a larger emergency fund.
Prepare for inflation and any anticipated lifestyle changes
As we have all learned only too well these past few years, inflation erodes the value of money. And that means that you may want to adjust the amount in your emergency fund periodically to keep pace with rising costs. Indeed, a fund that may have been sufficient a few years ago might be inadequate today.
Finally, when determining how much of an emergency fund you need, consider any upcoming lifestyle changes, such as having a baby or moving somewhere new. These may increase the amount you need to save.
So the answer is…
It depends. Yes, experts recommend saving at least three month’s worth of living expenses, but the right amount for you will depend upon your unique financial situation. The smart move is to err on the side of more, rather than less.
