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$1000 emergency fund? 6 months expenses? 1 year salary? Throw them all out the window!

When I first started getting serious about having our financial house in order, the first piece of advice I got from all the experts was – have an emergency fund. OK, got it, I will work on that! Umm… but how much should I have? No idea. The advice I got ranged from $1000 baby emergency fund to 1 year salary. That is a pretty wide margin to choose from.

How much should I really have? Is there anything called saving too much for an emergency fund? What are the assumptions under these “X” month’s salary advice?  I was confused. So I decided to throw all the rules out the window and make my own set of rules on how much emergency fund I should have. During the course of the last 4 years my emergency fund evolved from a baby emergency fund to much more as we started getting financially disciplined.

How much emergency fund do I need? – Baby emergency fund

First of all, when starting out, we just started adding $50 to emergency fund every month, because if we waited to do the whole calculation and try to figure out the perfect amount, we would have kept waiting. No, we wanted to start… with whatever we could. We targeted $1000 as a first milestone.  We sold whatever we didn’t need and made it sort of a game to find things to sell :) We hit the $1000 milestone and wanted to figure out how much emergency fund we would ideally like to set aside – as a short – medium term goal.

This is where we hit a snag. You see, my husband is an optimist and I am a pessimist.

How much emergency fund do I need? – For the Optimist

how much emergency fund do I need for the optimist

My husband wanted to save one month’s living expenses and be done with it. I found all sorts of problems with this, but we had to start somewhere, so after our baby emergency fund, 1 month living expenses seemed like a good goal to have.

We started figuring out what our one month’s living expenses would be. We could have just taken our spending plan and saved that much, but if we are only saving one month’s living expenses I wanted to include expenses that will change when we have to really touch the emergency fund.

If I lost my job, I won’t need to do dry cleaning and we definitely won’t eat out as frequently as we do when we are both working. So those expenses can go. And some expenses go up. When I was looking for a job, my phone bill went through the roof. I need a job, so that is not the time to cut on phone bills.  Excel to the rescue! I took our spending plan and marked each category as (1) Stay the same (2) Will go up (3) Will go down.

This needs careful consideration. Some people might think they can just cut out child care if they lost their job, but will you be able to make it to the interviews without child care? Go through your budget item by item and check which ones you will still need and which ones needadjusting. When you are done with this step you will have something like this -

Emergency Fund Budget

I now had my target amount and the target date I wanted to have this goal accomplished. I opened a separate Ally bank subaccount and direct deposited the required fraction every month.

How much emergency fund do I need ? For the pessimist

Around this time came the great recession. One of my friends lost his job. It took him 5 months to find a job. Now the pessimist in me was really awoken and cursing me for not saving more. I sat down again with all our expenses and did more calculations. This time I considered a few more issues:

  1. Job security/Number of months I expect to be unemployed
  2. Possible emergencies
  3. My personal situation.

Job Security & Unemployment period

There are a few things that would have made it difficult for us to find another job immediately. Both of us are in a specialized occupation, so it is not very easy to get another job. Specialized occupation also means, above average pay. In all probability we might have to take a lower paid job than the current one. So longer time without pay and even longer time with a pay cut. We can’t expect any severance and due to our personal situation, we won’t apply for unemployment either.

On the plus side, we are not in the same field, so we “might” not get laid off at the same time. But we never know. I looked at the job postings and based on our prior experience and the time it took some of our friends in the same field to find a job, I came up with a potential unemployed time – 3 months.

# of months I expect to be unemployed : 4 3 (Previously, I had incorrectly shown the number of months I expect to be unemployed as 4, when, instead, I had used the number 3 in my calculations.  I have fixed this error now.  A big thanks to Amber for pointing out the error.)

How much emergency fund do I need considering my job security : Amount needed for one month X expected # of unemployed months -> $1390 X  3 = 4170; so I will absolutely need ~$4200 to feel safe.

Possible Emergencies

I would like to plan for every single emergency in the world, occurring at the same time, because I am a firm believer in Murphy’s law. The logical me knows that would be stupid, but we did consider some emergencies together. For example, Job loss + accident; Job loss + health problems. Nothing major but at least one major and a minor emergency put together. These are the expenses we considered -

  1. Car Insurance deductible $500
  2. Health Insurance Premium in case of job loss (COBRA) $400 X 6 (peace of mind time frame)
  3. Health Insurance Copay for 3 doctor visits $60
  4. Cushion for other expenses $300
  5. Total : ~$3500 for Murphy

Considering my personal situation

Every family is different and could have situations that cannot be accounted for in the general emergency fund advice. But that doesn’t mean we can ignore the personal situation right? For us, it was a trip to our home country in case we needed to make a quick trip to help the parents.

2 RT tickets (bought in a short time frame, which means we can’t hunt for deals) : $4000 (yes, it is that expensive)

We are also a two income household, so we could have some breathing room even if one of us gets laid off. So our situation is different from a single income household. If you are single, that is a totally different situation than if you are married. The stakes are even higher if you have kids. If you/anyone in your family have any special medical conditions that require a good amount of money every month, please don’t rely on any rule of thumb. Are there any expenses that will be unique to you? Do you own calculation.

So for us the “ideal” emergency fund was : Monthly expenses X “peace of mind time frame” +Murphy money + 2RT tickets to our home country = ~$16000 

Too much? May be. But that will help me sleep peacefully at night so it is worth it. Finally, I plan on doing this calculation every time there is a major life change – New house ( to make sure I factor in the mortgage and all the expenses that come with it, and may be add in an extra house maintenance money) or when we have a baby.
I personally think it is a good idea to recalculate the bare minimum at least once in 2 years. Your expenses might have changed in those two years. You don’t want to be in a situation where you “think” you have saved up 6 months of expenses only to find out you have just 2 months when you really need to use it!

Now we don’t have the entire thing saved up. I would like to know the amount I am aiming for to keep me on course. As we are already past the baby emergency fund and the one month expenses, we are slowly trying to save to hit the ideal emergency fund amount.

 

Where we have our emergency fund parked

I realize that deciding to have a large amount of emergency fund, I am trading the opportunity for it to grow. So we have our emergency fund in different levels of liquidity. We have a couple of hundred dollars in cash, a few more hundred in a checking account that we could take out as long as the ATMs are working. The rest of it, we have it in a Ally Bank Sub account (check out the Online Savings page for current interest rates of various online savings accounts). You can also have this in a rewards checking account or other high interest savings account like American Express or Capital One 360.

Recently we decided to up our emergency fund to 8 months expenses for personal reasons. Instead of keeping this in a savings account, I decided to open a ROTH IRA to keep our additional emergency fund. Hopefully, we won’t have to touch this and it will be waiting for us when we retire, but if needed it is there to keep us afloat during those rainy days.

So personally for us, it has not been one rule of thumb. It has evolved and been tweaked to match our risk tolerance. I have attached a spreadsheet to do a similar calculation. The first column of the sheet has all possible expenses, you can remove the expenses that are not in your regular budget/spending plan. Enter the regular amount you spend in the second column as per your budget, the third column is the adjusted budget, in the fourth column fill in the additional personal situation amounts. It should give you the different recommendations.

Now I would like to know how you have approached your emergency fund. Do you have a fixed amount or x number of months’ worth of expenses? Do you also have cushion for other contingencies? Or just bare minimum of expenses?

{ 21 comments… read them below or add one }

Hunter @ Financially Consumed

Finally, a fresh perspective on emergency funds. THANK YOU!

Our Roth IRA accounts are the main emergency fund, and we also have line of credit approved and in-place if that is needed for a super-large emergency. Other than that we have a strong insurance plan.

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Sustainable PF

We park our emergency funds in a Tax Free Savings Account. The interest is barely beating inflation but it is nice to have some money squirrelled away.

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Andrea Travillian

I love how well thought out your emergency fund is! We go by monthly expenses for our savings target, which I include luxury items so that I have an extra cushion. We also opt to go with the pessimist for emergency fund purposes (that would be me) this way we can both sleep at night. My husband jokes that I have an emergency fund for our emergency fund!

I found my happy point by trial and error on my feelings, I paid attention to when I finally felt comfortable. Every person is different so taking the time to figure out what is right for you is smart!

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Miss T @ Prairie Eco-Thrifter

Thank you for the thorough article Suba. The state and goal of our emergency fund has been a hot topic lately. This article will be very helpful for determining what we need to best cover our costs. I am emailing this to my hubby right now.

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Jeff @mymultiplestreams

I am doing 6 months worth based on personal expenses (assuming photography business goes totally under) with some padding. Starting a separate fund for housing and car situations, more to start attacking projects around the house (new windows, new roof, finish master bath)

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Jeff @mymultiplestreams

Oh I did want to question your parking of some of this money into a retirement vehicle and your thoughts behind that. My thoughts are to keep it as liquid as I can, and in a retirement vehicle wouldnt you be paying a penalty and taxes if you needed to pull it out?

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Eric J. Nisall

Miss T is right, there has been quite a buzz on this topic, probably due to the fact that the jobs just aren’t being created and people are out of work for longer than expected. I keep reading people talk about credit lines available as emergency funds, but I don’t agree with that methodology. Credit lines have to be repaid, so by using them, all a person would be doing is putting themselves in a deeper hole.

I also appreciate and like how you made up that graphic breaking out the different life stages, since that plays a big role in how one would go about their emergency fund. For someone who is just starting out , and maybe still living at home (or someone who had to move back in), the fund wouldn’t need to be as substantial as someone who has a history of medical issues, or a person who is a care provider for another. In those cases, the results of unforeseen events would have dramatically different repercussions and therefore the planning would have to be specific and tailored to each person’s individual or familial situation. None of that “everyone should have $X or X months, since it just doesn’t apply equally to every person.

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Ashley @ Money Talks

We have 6 months of expenses in our efund. I’m comfortable with this amount. We do have other savings, while they are earmarked for other things, like vacations and eventual car purchases, they could certainly be used if my husband got laid off.

I think all the points you brought up are spot on. It’s a personal decision that needs an individual answer.

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Jeffrey Trull

I have $1k as a dedicated emergency fund that I keep in my savings account that I have access to with my ATM card. I have additional savings to draw on, but I’d prefer to have closer to $9,000 for my fund, which I think I could live on for 4-6 months if need be.

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Money Varta

Emergency fund is something that totally dependent on your profile and there cannot be any fixed emergency fund as advised by the experts that would be best for you. It is important to figure out what kind of earning source you have and risks associated with that source as well as your monthly income and expenditures. these three things will make the difference not the expert’s advise.

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krantcents

I do not have a specific emergency fund. I have some savings and descretionary income that will take care of most emergencies. I rather have my money working for me.

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SB @ One Cent At A Time

I have an emergency fund of one year’s expenses. For many it might be a bit more than required, but it gives me a good night’s sleep. Fund is very liquid in a interest bearing checking account and saving account.

Good perspective on emergency funds.

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Jacob @ My Personal Finance Journey

Wow. Very good post. I typically recommend simply keeping 6-9 months of expenses in an emergency fund. If you run the 9 mo of expenses figure for your situation, I come out with around $12,000, which is in the ballpark of what you figured here with the exception of the round trip tickets.

So, I think the 6-9 months recommendation is a good way to “keep things simple” and get people started towards an emergency fund goal. However, once they accumulate that savings it’d be good to go through this list to provide further visibility.

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Well Heeled Blog

Right now I have 1.5-2 years of living expenses in cash. I think it doesn’t quite make sense to keep that much money in cash beyond that, unless you have another goal that you are saving for in addition to the E-Fund.

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Mittoo

Great post!

Emergency fund planning has been a concern of mine as I plan for the uncertain.

I like the way you have broken some things down. I think the ideal amount to have readily accessible for me would be about $10,000 (8-10 months of living expenses), plus another $5,000 for emergency trips/expenses.

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Buck Inspire

That’s the most detailed breakdown of emergency funds I’ve seen. Excellent job! I’m shooting for a six months of expenses emergency fund. Only recently did I get a good feel for my monthly expenses. They are sitting in a minimal savings account. I really should park it in my ING Direct. Thanks!

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AP

Hi
Nice post. Math error. You said
“# of months I expect to be unemployed : 4
How much emergency fund do I need considering my job security : Amount needed for one month X expected # of unemployed months -> $1390 X 3 = 4170; so I will absolutely need ~$4200 to feel safe.”

That would be the emergency number for being unemployed for 3 months, not 4. So you actually should have $5560 for your unemployment figure. (sorry)

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CHaley

Thanks for approach on emergency fund. I’m glad to know I’m not the only one who wants to plan for everything to go wrong at once (car accident causes husband to be out of work, fill in while waiting on disability, COBRA, insurance deductible, and medical expenses). For some reason, my husband thought 15k was unreasonable.

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anexactinglife

I laughed at “baby emergency fund” thinking it meant a fund to help with an unexpected pregnancy, LOL!

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Victoria

Awesome article! Setting up an emergency fund based off of your personal need is the only way to go and you explained that perfectly! I strive to have at least 6 months of my expenses saved. Sometimes it’s hard to figure out where the money will come from to fund the E.F). Kudos to you for shedding light on such an important topic!

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Connor Gardiner

I dipped into the fund when my wife went out on maternity leave. I’ve found in general, the emergency fund comes into play when you have zero money to pay your bills. That’s the only time that I’ll use it and I’ve gone a decade (until recently) without tapping into it.

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