Rule of Thumb: How Big Should Your Emergency Fund Be?
Many of us are familiar with the concept of an emergency fund – having money set aside in case things don’t go according to plan. But what many of us don’t know is how big our emergency fund should be. Fortunately, there are easy-to-remember rules of thumb that can help us determine how large our emergency fund should be.
Why It’s Important to Have an Emergency Fund
It’s important for everyone, regardless of financial background or situation, to have an emergency fund. No one knows what life will bring, and it’s better to be prepared for any eventuality. An emergency fund is the cushion that will allow you to pay for unforeseen expenses without going into debt. It will provide protection against life’s big expenses, like job loss, medical bills, or home repairs, so you’re not forced to use a credit card or tap into your retirement funds.
How Much Should Your Emergency Fund Be?
Before we jump into the various rules of thumb you can use to judge your own emergency fund requirements, it’s important to keep in mind that these numbers are just guidelines. Every household has different financial needs and obligations, so the amount you need to save depends on your individual situation.
Six-Month of Expenses Rule
One of the most popular rules of thumb for determining the size of your emergency fund is the six-month of expenses rule. This states that you should have enough money in your emergency fund to cover six months of your living expenses.
This rule makes a lot of sense because it helps you to think about the maximum amount of time you’d have to cope without a job or other income stream. Having money in the bank for up to six months of living expenses implies you have the financial buffer needed to find a new job without taking on debt.
If you have an irregular or variable income, or if your job is in an industry where job loss and layoffs are common, then it’s possible you may want to save more than the six-month of expenses rule recommends.
Three-to-Six-Month of Expenses Rule
While the six-month of expenses rule works well for many, there are others who may want to go with a lower threshold. This is where the three-to-six-month of expenses rule comes in. This rule, while not as conservative as the six-month rule, still provides plenty of protection against most, if not all, of life’s unexpected expenses.
This rule speaks to those who have a reliable source of income, but still want to be prepared for anything. You might have family or other obligations that you must take into consideration.
One-Month of Expenses Rule
At the other end of the spectrum, some may prefer to go with the one-month of expenses rule. This is a good rule of thumb for those who don’t like to worry about the future and would rather just save for the basics.
This rule implies that if you can get through the next month without additional income, then you’re set. Just one month of living expenses in the bank can cover most of the immediate expenses that life can throw you.
The Minimum Amount
There’s also the purely practical approach of having an emergency fund of at least $1,000, regardless of how much your living expenses are. This is often referred to as the minimum amount. It serves as an initial cushion and a starting point, even if it’s not enough to cover an entire month of living expenses.
What Your Emergency Fund Shouldn’t Be Used For
While an emergency fund is there to cover unexpected expenses that pop up, it’s important to remember that it’s not for everyday purchases. You should not use your emergency fund for day-to-day, routine purchases like groceries and bills. These should be covered by your regular income or budget.
Make Sure You Build One
No matter which rule of thumb you use, it’s important to think about building an emergency fund for security should things go wrong. Having an emergency fund in place will provide you with the peace of mind that comes from knowing you can take care of yourself and your family if need be. It will also keep you from relying on debt to get you out of a bind.
Having an emergency fund is important to protect yourself against life’s unexpected expenses. It’s important to choose the savings amount that works best for your family and lifestyle. A good place to start is with one of the rules of thumb discussed in this article. With any luck, you’ll never have to tap into your emergency fund, but it’s always good to be prepared in case you need it.