If you've ever done some research into the best way to build an emergency fund, you probably have this rule branded into your grey matter: A solid emergency fund should cover three to six months' worth of expenses.
Sounds simple, right? That's true until you start to translate the rule into dollars and cents. Then, all sorts of questions start to arise. First, how do you measure expenses? Should you just save three to six months' worth of take-home pay? Or should you refine the measurement and save only the amount you would need for necessities (assuming you'd stop eating out and buying comic books in case of a real problem)?
Then, you realize the difference between three and six months' worth of anything is a lot. Is it better to stick closer to three months of expenses, or play it safe by trying to save as much as six months?
Before we start, let's quickly review the reasons you need an emergency fund. First, emergencies happen. Second, when they do, you'll need some money. Third, if you don't have an emergency fund, you'll be turning to your credit cards to bail you out. Fourth, credit card debt can overwhelm you if your emergency is severe or lasts a long time. Have I convinced you yet? If not, read this article from the Savings Center for even more reasons.
Now, on to the calculations. In determining how to calculate your monthly expenses, think about how much of your paycheck you spend each month. If you regularly spend every penny, it may be simplest for you to think of expenses as the total of your take-home pay. If you save and invest 20% of your paycheck each month, you can safely subtract that amount from your expenses calculation.
Let's say you regularly participate in an expensive hobby, like motorcycle racing or scuba diving. If you know you would cut out that activity to save money in the event of an emergency, subtract those costs when measuring your monthly expenses.
For everyone else, I would counsel that you think about your monthly expenses more like your take-home pay instead of just your necessities. It's true that if calamity hits, you will probably stop buying fancy coffee and start ironing your own shirts, but you may have new expenses you haven't factored into your equation. If you or someone in your family suddenly took ill, for example, you could be facing steep medical expenses, new child-care needs, or even travel costs.
In general, no one's ever complained about having too much money in the bank when a true emergency or (heaven forbid) emergencies strike.
Now, do you need three or six months' worth of expenses? Unfortunately, there's no way to predict your future emergencies or your needs. This calculation will necessarily be a judgment call, factoring in your tolerance for risk and your situation.
If you're single, renting an apartment, with only your dog to support, three months may be fine. If you know the job market in your region or your field would make any job search a long endeavor, you'll want to save more.
Let's say you're a dual-income couple who owns their own home. In this case, you may want to save more than three months of expenses to make sure the mortgage gets paid on time. You'll also want to think about the size of your relative salaries. If the big breadwinner gets laid off, you'll be in a more dire condition. If you both make roughly the same income, you may be less pinched. Either way, you may feel more comfortable with four or more months of expenses in the bank.
Once kids (or any other dependents) enter the equation, it gets harder to build a big emergency pot, but it also becomes more important. If there's only one breadwinner in a household with children, you'll rest easier with six months' expenses in the bank.
Maybe, for you, three months seems like plenty. Maybe you can't sleep at night without knowing you have a six-month stash of emergency cash in the bank. Or, you may decide to strive quickly to build a three-month reserve but make it a long-term goal to reach six months.
Whatever size you choose, don't be scared off by the bottom-line figure you have in mind. Any amount saved for a rainy day will serve you better than nothing.
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