How much should you keep in your emergency fund?

Photo by Jason Leung on Unsplash

With these unprecedented times and a high likelihood of higher than average inflation in the coming years, I think it makes sense to revisit the age-old question of how much to keep in your emergency fund.

There is no one right answer. However, there is a correct answer for everyone. By answering these questions for yourself, you can decide what the right amount is for you.

What is an emergency fund?

Before we get into the article’s meat, maybe it is best to figure out how an emergency fund is used. When I think of emergency funds and plan with my clients, I am looking at catastrophic events.

  • Job loss
  • Unexpected car repairs
  • Unexpected home repairs

What I am not considering an emergency is getting regular car maintenance done, wanting to go out with friends but not having the funds in your budget, etc.

You may look at emergency funds differently, so you will want to adjust how you read this article accordingly.

What are your monthly expenses?

It should not be a surprise to anyone that the first question to ask is based on how much money leaves your account every month. This will be the base for figuring out how much you need to have saved because we will look at your goal as a multiple of your monthly expenses.

When I ask about your monthly expenses, I am talking about every dollar that leaves your account each month. You can easily see this on nearly any bank statement with the month-end summary showing the total deposits and withdrawals in your account.

I like to add up that total withdrawal figure for the past 12 months and then divide it by 12 to get your average monthly spending.

What type of income streams do you have?

When considering your income, I am asking you to look at how steady your income is, how likely it is to lose a source of income, and how much that loss of income would impact you.

If you have a very steady salary job with zero concerns about layoffs or multiple income streams, you can keep a lower reserve set aside as an emergency fund. If you have a volatile job, contracting type position, or freelancing, you will want to keep more in reserve.

How much peace of mind do you get by having a cash reserve?

This is an intensely personal question that many people tend to overlook. It is imperative for some of us to keep cash handy because it gives us peace of mind knowing it is there. If you are one of those that like to have some money in reserve, it is not uncommon to build up to 12 months of expenses in their savings account.

For others of us, there is no limit to the amount of risk we will take because we are reasonably confident that we will always be able to come up with something to make ends meet. You may only keep two weeks or one-month cash reserves if you are someone in this position.

Then there is the majority of us that fall somewhere in the middle. Where do you fall on this spectrum? The more conservative you are, the larger your cash reserve needs to be.

It doesn’t matter if it is the best or worst financial decision; you need to decide what you are most comfortable with and build the plan accordingly.

The high-level overview.

Now that you know yourself a little better let’s look at some general guidelines to make your decision.

The bare minimum emergency fund should be at least one month of expenses. This would be ideal for one of the following types of individuals:

  • Focused on paying off debt
  • Working a very secure job
  • High tolerance for risk

The maximum emergency fund should be no more than two years worth of expenses. This is ideal for one of the following types of individuals:

  • Retired and living off their investments
  • Working a very insecure job with low monthly expenses
  • Extremely risk-averse.

Most people should aim to have between 3–12 months’ worth of expenses in their emergency fund.

What if you don’t have enough for your goal?

If you find that you need to save a little more to get into a comfortable emergency fund, don’t worry, it is very common to find yourself in this position. The key is to start putting money aside to get to that goal.

I was working with a client last year that needed to build his emergency fund to $2,500.00. He didn’t have anything in his account saved and was regularly using his credit card when his car broke down, or he needed to repair something on his house.

When we dug into his finances, we found that he was spending around $5–7 a day on gas station snacks. He was shocked at how much he was picking up these snacks and agreed not to go into the gas station one day per week.

That $5 per week would transfer to his emergency fund to start the funding process and give him a little cushion. He has now cut out going to the gas station three times per week and is nearly finished building his emergency fund.

It was a slow process that had a few setbacks, but by starting this process, it allowed him to completely change the way he looked at money, which is setting him up for long term success.

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