One of the most frequently asked questions in the personal finance realm is, “How much should my emergency fund be?” The question is usually answered with a canned response such as, “Three to six months of expenses.” Well, I have my own theory on the size of emergency funds, and it has more to do with me sleeping at night than a finance guru’s personal opinion.
Still, at some point excessive savers run the risk of saving too much for a rainy day. After all, there are plenty of sunny days to take advantage of, and doing so may require a little cash. Every situation is unique, but as a rule I would suggest not saving more than one full year of income in a fund designated for “emergencies.” Most (not all) job layoff situations are resolved within one year, and most large emergencies can be covered by the equivalent of twelve months of income.
You may be like us and have savings goals that reach higher than one year’s worth of income. That’s okay; just designate separate piles of money for each goal. For instance, when we become debt free I plan to start saving in a “Financial Independence” fund (it’s purpose is self-explanatory) to hold proceeds from my working capital in other investments. Ideally, I would like to have at least one year of income in this savings fund, if not more, but it will be kept in a separate fund (ING Direct allows you designate separate, or “sub-accounts”–great for separating savings goals).
Some folks lean towards the Dave Ramsey principles of a very small, beginner emergency fund while you are working to become debt free. I understand the logic behind this idea, but only having $1,000 to our name feels a little risky to us. I would rather accumulate a minimum of three months of expenses and then attack the debt. After all, $1,000 doesn’t go very far these days towards household repairs, replacing dead appliances, or surviving a layoff.
So How Large Should My Emergency Fund Be?
The bottom line is there is really no right or wrong answer to the question. Stop and think about all of your liquid assets and gauge your immediate reaction. Are you comforted by this amount? Are you worried it won’t be enough to cover the next bill from your mechanic?
Let that initial response guide you. If you are not at peace knowing how much you have in savings, add more. And because men and women often have a different number that makes them at peace, financially, couples should opt for the larger of the two amounts required to make each spouse feel secure. Once you reach your target amount dedicated for “emergencies,” attack your debts and then move on with your financial life by funding retirement, college for your children, etc.
How much is in your emergency fund? If you don’t want to share numbers, just tell us how many months of expenses you have saved up.