How Big Should Your Emergency Fund Be? Find Out in 4 Easy Steps

Saving money for emergencies is vitally important. An older Pew Trusts study found about 60% of households had experienced a financial shock over the course of the prior year, with those shocks carrying a median cost of $2,000. Being unprepared for this could leave you reaching for your credit cards and struggling with the fallout for a long time to come.

But just how much emergency money should you have in a savings account? Here are four easy steps to help you decide what an appropriate rainy day fund looks like.

1. Consider your debt

If you have a lot of high interest debt, it makes little sense to save up a huge emergency fund. After all, the average credit card interest rate was ​​21.19% as of August 2023. If you put many thousands of dollars into a high-yield savings account earning you about 4% interest instead of paying extra on that high-interest debt, you'll be losing a lot of ground.

You should have some money for emergencies though, even while working to repay debt. Otherwise, any unexpected expense could force you to borrow again and potentially cause you to lose momentum since you'll find yourself back owing more. You may end up discouraged that you'll never break the cycle.

It's typically a good idea to save around $1,000 for an emergency fund prior to making extra debt payments. That's not so much that it will set you way back in your payoff efforts, but it's enough to cushion you against more minor disasters that could have you reaching for your cards.

2. Calculate your essential living expenses

If you don't have a lot of high interest debt, you'll want to prioritize saving an emergency fund that covers your essential expenses for a few months. This can help you to avoid disasters like late payments or even foreclosure or car repossession if something goes wrong and you can't pay the bills from your income.

You don't need to necessarily have enough to cover every monthly expense, though -- only the essential ones you'd keep incurring in a time of crisis. If you budget $100 a month for a pedicure and have five streaming service subscriptions with a total price tag of $100 a month, you could easily suspend spending $200 a month on these in case of emergency.

Consider the costs you'd definitely want to continue incurring even if you lose your job or get sick and can't work, and use that to determine how much your emergency fund should be.

3. Determine the level of risk you face

The general rule of thumb is to save enough money in an emergency fund to cover three to six months of living expenses. But that's a pretty wide range. Say you found your essential expenses were about $3,500 a month, including costs like rent, food, and bills. In that case:

• Saving three months of expenses would mean saving $10,500
• Saving six months of expenses would mean saving $21,000

There's a big discrepancy. So, you'll need to think about how long you'd likely need to rely on your savings -- and that decision is based on the level of risk you face.

If you are:

• Prone to health problems
• In an unstable job
• Are the sole source of support for your dependents
• Have an old house prone to major issues
• Work in a field where it would take you a long time to find new work if you become unemployed

Then you may want to err on the side of a six-month emergency fund. Or you could be even more conservative, defy the experts, and decide to save nine months or a year's worth of essential expenses.

If, on the other hand, you have:

• An extremely reliable income
• Are in perfect health
• Rent your home
• Have great health and disability insurance coverage

Your risk may be lower, and you could opt for just a three-month emergency fund.

4. Save enough to cover expenses for a reasonable number of months

Once you've decided how much risk you face, you can make an informed choice of how many months of living expenses you need saved. Then just multiply that amount by the essential costs you incur. So, if you've opted for a six-month emergency fund with your $3,500 of monthly expenses, your goal would be to save $21,000.

By going through these four steps, you can make an informed choice and ensure you have the necessary funds set aside to protect your future financial security. Then you just need to work on saving that money ASAP by transferring funds automatically from your bank account, working a side hustle for a while, and depositing "found" money (like cash gifts for holidays) in your emergency savings.

When disaster strikes, you'll be very glad you took these steps to save enough to feel secure.