We all know it’s important to be prepared financially in case things don’t go exactly according to plan. The question is, how big should your emergency fund be to adequately face the unexpected?
According to Motley Fool finance expert Dayana Yochim, it comes down to one simple rule.
“Basically, the less steady your paycheck and the more people who depend on your income to survive, the larger your emergency fund should be,” she said on The Motley Fool Answers podcast.
Emergency fund basics
But let’s start from the beginning. What is an emergency fund? Pretty much exactly what it sounds like — a self-funded cash reserve set aside for emergencies – an illness, the loss of a job, or a big expense. Just like insurance, you don’t touch it until you need it.
So how much cash are we talking here? The rule of thumb is to contribute enough to cover 3 to 6 months’ worth of basic living expenses — the “must-pays” like rent, mortgage, medication, food, utilities, and car payments.
But of course, that rule isn’t going to apply to every situation and every household. It’s a good starting point for determining the ballpark size of your emergency fund, but you also need to consider your personal financial circumstances. Think about tacking on a few more months’ worth of cash if…
- You’re a freelancer, contractor, or anyone without a full-time salaried gig.
- Your paycheck is based on a few big clients.
- Your company is on shaky financial ground or you work in a high-turnover field.
- You have a spouse/partner who’s unemployed or works part-time.
- You have kids.
- There aren’t many job prospects in your current field.
- Your skills are in low demand or you’re highly specialized.
- You don’t have easy access to other money — like a home equity line of credit, a college fund, or other savings.
Where do I park my emergency fund?
This fund isn’t designed to earn you massive returns, so don’t keep any emergency money in stocks — they’re too volatile, and you need to be able to count on this fund always being there.
But you also don’t have to settle for zero appreciation — savings accounts don’t pay much more in interest than your mattress does.
There are other options — like money market funds (which will pay you more than a savings account) and short-term CDs and bonds. Not only are these guys low-risk, but because many come with early withdrawal restrictions, they’ll also keep you from withdrawing money before you need it.
If these options don’t catch your fancy, check out some unconventional options in this Foolish article.
The Foolish bottom line
Don’t worry about coming up with the perfect dollar amount to put aside for your emergency fund —there’s no magical, one-size-fits-all number. The important thing is that you start saving and adjust accordingly as your employment situation and family needs change.
If you need help saving money to supply your emergency fund, read over our Foolish budgeting and saving tips. Not sure how much money you really need for your cash cushion? Check our Emergency Fund Guidelines for some specific tips. And enjoy our Motley Fool Answers podcast, and all of our other Foolish podcasts, at our podcasts page, or on iTunes.
— Answer provided by Motley Fool intern Caroline Jennings