How much money you should have in your emergency fund
What is an emergency fund?
Let’s start at the beginning. An emergency fund is some amount of money you have saved up and keep in a safe place in case of emergency. This money should be easily accessible, as emergencies are usually unexpected, and its meant to support your through a certain period of time while you solve the emergency and get back on your feet.
The emergency fund general rule of thumb
The commonly accepted rule of thumb says you should have 6 months’ worth of savings in your emergency fund. This means adding up all the fixed expenses you have each month and multiplying that number by 6. If you are following the 50/30/20 budgeting rule, this are your “wants”. Multiply you “wants” x6 to know how much money you should have saved up in your emergency fund.
It’s worth noting that this rule of thumb is meant to be applied to the entire household as a unique entity. If your household has two earners you could, as an individual, go by with 3 months’ worth of savings instead of 6, assuming the other household earner also has 3 months’ worth of savings.
The emergency fund unemployment rate rule of thumb
A different rule of thumb which also makes a lot of sense is the unemployment rate rule of thumb. This rule tries to account for the stability (or lack of it) of the economy where you live in. We could probably all agree that loosing your job during a period of crisis and depression is much more of a big deal than loosing it at a time when everyone is hiring and the economy is booming, so why not take that into consideration when sizing your emergency fund?
The unemployment rate rule of thumb says you should add up your fixed expenses for a single month (just like before) and multiply it by the unemployment rate in your country. So if the unemployment rate in your country is 5% you should have 5 months’ worth of savings, or if the unemployment rate is 8% you should have 8 months.
This might seem crazy to some who live in countries with unemployment rates of 12%, 15% of more, but if you try to be honest about how long it can take the average worker to find a new job in that economy you’ll soon realize having a big emergency fund is actually necessary.
When should you use your emergency fund?
Some people don’t know when its ok to use their emergency fund and when it isn’t. Generally speaking there are only two scenarios when you should tap into your emergency fund:
- If you lose your job.
- If you have an unpredictable medical emergency.
Nothing else is important enough to justify touching your emergency fund.
If you do need to use your emergency fund you’ll probably wont be at your best, and once you’ve overcome the emergency its easy to think “I need a break” or “after all I’ve gone through I deserve this or that”. However rebuilding your emergency fund should be your number one priority after overcoming an emergency. The sooner you rebuild your emergency fund the sooner you’ll be able to go to bed knowing you are financially covered against the uncertainty that the future holds.
Updating your emergency fund
Some people are surprised to find out their emergency fund will last them shorter than they expected when they need it.
It’s important to update your emergency fund as your fixed expenses change over time. Imagine you’ve built your 6 months emergency fund and have also managed to save enough to put a down payment on a new car which you’ll finance over a period of three years. For the next three years your car loan will be a fixed expense, and you should update your emergency fund accordingly.