It's a general rule of thumb that you should have an emergency fund set aside to cover your expenses in case you lose your job or are otherwise unable to work. Generally, experts say you should have between six months and a year's worth of your living expenses in a separate and readily accessible account. And, this is in addition to any retirement or college savings you may have.
However, a lot of people tend to underestimate how much their "living expenses" are. Putting six months' worth of your rent and utility bills in an account is by no means enough to actually last you for six months. While it can be scary to do this kind of worst-case scenario thinking, you'll be in much better shape if you prepare for the worst.
Here's what you need to budget for when you come up with your target amount for an emergency fund.
Housing and related expenses
The most obvious thing you'll need to pay for if you lose your job is a roof over your head.
So, add up your rent (or mortgage payment), your average bills for electricity, water, television, Internet, sewer, and any other recurring costs involved with simply maintaining your housing situation. For example, if you have a contract to pay $30 per month for your home's alarm system, make sure you include that.
The goal should be to plan well enough that you don't have to break any contracts or deprive yourself of your basic lifestyle, like by cancelling the cable. Once you've added up all of the costs, multiply by six and write the number down.
Car and related expenses
Next, figure out how much it costs you to own and operate your car. If you're out of work, you'll need to drive to job interviews, so this is another important category.
Add up your car payment and the monthly cost to insure it. Then, budget for gas, tolls, and other operating costs. You likely won't be driving as much if you're out of work, but you still want to budget a reasonable amount for this.
Don't forget to factor in maintenance costs for the car, such as oil changes every three months or so. Multiply this number by six, and add this to your housing number.
Other recurring bills
Now add up all of the other recurring expenses you have. While it may be possible to switch to a cheaper mobile phone plan, you'll still need to budget for the cost.
And don't forget about your student loan payments and credit cards. If you're out of work, it's OK to just make the minimum payments on your credit cards for a little while, but you'll need to budget for that. There's no reason to sacrifice your good credit if you plan properly.
You still have to eat
The biggest mistake people make when preparing an emergency fund is forgetting that they are a human being. Even in a financial emergency, you'll still need to eat.
When you're out of work, it's no time to be going out to eat a lot or buying expensive items at the grocery store, but make sure to account for a reasonable amount of money to buy groceries, do laundry, and complete other day-to-day tasks.
Add up all four categories. Are you surprised at how much six months of expenses actually costs? How does your emergency reserve fund compare with the number you just calculated?
Six months is a good target, but round up to be safe
Hey, things happen in life that we don't plan for. What if your car gets a flat tire? Or what if you get sick and need to go to an urgent care office?
The point is that there is no way to plan for every little thing, so you need to plan for the unexpected. So, take all of the expenses we've already mentioned and add 10% or so as a cushion.
If you manage to get six months of your actual living expenses and a little extra "just-in-case" money set aside, you'll be in better shape to weather any financial storm than most people are.