One Mistake You Can't Afford to Make When Calculating Your Emergency Fund
- You should have a minimum of three months' worth of expenses in your emergency savings.
- It's important to account for all of the expenses you might incur during that time.
- Think about quarterly expenses, along with your regular monthly bills -- and try to anticipate possible future expenses.
It could really lead you astray.
Given the number of experts who have been sounding recession warnings, a lot of people have emergency savings on the brain right now, and understandably so. If a recession hits and the labor market starts shedding jobs, you may need to rely on the money in your savings account to stay afloat in the absence of your regular paycheck.
Now as a general rule, you should aim to have enough money in your emergency fund to pay for at least three full months of essential bills. And for better protection, it's good to aim for a savings account balance that can cover six months' worth.
In fact, some financial experts are even saying that having enough savings to cover a full year of bills makes sense. Granted, this advice has largely come on the heels of the massive unemployment crisis that hit in 2020. But it's certainly not bad advice to follow.
Either way, you may be at a point where you're trying to build up your emergency fund to make sure you're covered in the event of a broad economic downturn. But when running those numbers to see how much savings you need, there's one trap you should try to avoid.
Don't forget expenses you don't pay every month
Most of your bills are probably expenses you pay on a monthly basis -- things like your rent or mortgage payment, auto loan payment, utility bills, and food costs. But you may have expenses that don't pop up every month, but rather, every quarter, or even every year. And it's important to account for those expenses in case you end up in a situation where you need to dip into your emergency savings to stay afloat.
Let's imagine you lose your job and need your savings to live on for three months. Let's also assume you thought you built yourself a three-month emergency fund, only to realize you forgot to add in money for your property tax bill, since you only pay it once a quarter. Suddenly, you might have a major shortfall on your hands.
That's why it's so important to think about all of your expenses in the course of calculating your emergency fund. But don't just rely on your memory. Instead, comb through the past year's bank and credit card statements -- all of them. That way, you'll be less likely to gloss over a bill that only comes around on occasion.
At the same time, do your best to anticipate new bills. If your child is getting braces at the start of the new year, for example, that could mean having to pay the orthodontist $250 a month once those braces go on. That's an expense you'll want to incorporate into your savings.
Make sure you're set for emergencies
If you're going to make an effort to build yourself an emergency fund, you might as well do it right. Remembering your one-off expenses could spell the difference between having enough cash on hand to get through a financial crisis and having to resort to debt or other unwanted extremes when the going gets tough.
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