Life is full of unexpected surprises. Whether it’s a medical emergency, car problems, job loss – there will always be something. It’s a good idea to have a small cushion to cover your costs while you get yourself back on your feet.
Most personal financial experts agree that before investing you should start an emergency fund. It’s a proactive way of protecting you and your family from random crappy events.
How Much to Save?
The general rule of thumb is 3-6 months of living expenses. But I would argue it depends on your situation.
If you’re a teacher with high job security, you might hold less. If you’re in a sales role with inconsistent income, it would make sense to have more in your emergency fund.
My best advice is do what works for your situation.
To calculate how much, add up your monthly expense. This would include your mortgage/rent, utilities, transportation cost, food, etc. This doesn’t have to be an exact dollar figure, but you should have a rough idea of how much you spend monthly.
Let’s say your goal is 6 months of savings for your emergency fund. If your monthly expenses are $5,000, you would want $30,000 ($5,000 x 6) in your emergency fund.
Where to Save?
Now that you know how much, you will need to put that money somewhere safe and accessible. This could be at your local bank in your checking or savings account.
When you have a big chunk of change sitting in the bank you may be tempted to use it for non-emergencies. To avoid the urge, it’s common for people to open a separate bank account.
For example, I use my local bank for my checking and saving account. My emergency fund is at a separate online bank that I do not check as often.
The following can be used as backstops in case you deplete your emergency fund:
- Home equity line of credit
- Taxable investments
- 0% interest rate credit cards
- Roth IRA contributions
When Can You Use It?
The largest emergency most of the population is planning for is if you lose your main source of income. This is where the whole number of months of expenses comes into play.
But that’s not the only thing they are used for. What if you have an unexpected medical bill? What if you need a new roof? There are many situations where you would want to dip into your emergency fund.
Ultimately, it’s up to you to decide what your emergency fund can be used for. Ideally, you want to avoid using it for non-essentially items. Just make sure whatever you decide, you stick to it.
There is no set amount that everyone should have in their emergency fund. It depends on several factors – risk tolerance, career, and more. Your emergency fund acts as self-insurance and can help give you peace of mind. If you have a cash cushion, your financial plans can’t be derailed by these unexpected events.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.