Forget Everything You Learned About Emergency Funds

It’s an age-old question in personal finances:  How big should my emergency fund be?

The answer should be there is no answer.  

The size of your emergency fund is a function of your personal situation, family status, employment stability, etc.

However, there is no shortage of “financial gurus” who are quick to share a hard/fast rule such as:

  • Save $1,000 in a starter emergency fund
  • Save 3-6 months of expenses (lean towards six if you are a one-income family)
  • Save one year of income, or expenses

A Personalized Emergency Fund Formula

I think financial guidelines are generally good, because they do at least provide a target for which someone can aim.  I’m also a fan of people like Dave Ramsey.  However, I don’t like blindly following the advice of some guy on the radio who doesn’t know your personal situation or your tolerance for risk.

Instead, I would much rather people adopt a formula which helps them sleep more soundly at night.

After all, there is no softer pillow than money in the bank.

So here is the formula that has worked for our family.

Starter Emergency Fund

In our starter emergency fund we aim to keep the following:

  • $1,000 per family member
  • $1,000 if you own a home
  • $500 per vehicle owned

In our case, that works out to $6,000 saved in a low-interest, but highly liquid, savings or money market account.

I recognize that is a good bit more than what others recommend, but I’ve discovered the hard way that trying to get out of debt or pile up cash for a down payment is like running on a hamster wheel if you do not have some dedicated emergency cash.

Let’s play out a real world example for those comfortable with only keeping $1,000 in a starter emergency fund while tackling an $8,000 credit card bill, or $50,000 in student loans.

Side note:  if you have that much in student loan debt, at least consider refinancing with SoFi to get that interest down.

Two months in your hot water heater bursts on Monday and you catch a nail in the sidewall of your tire on Friday.  There goes your $1,000 emergency fund.

Next week, before you can rebuild the starter emergency fund, your air conditioning goes out at home.  You put the repair bill on your credit card.

And so begins the vicious cycle of living with credit cards and no cash in the bank.

The Fully Funded Emergency Fund Formula

You won’t need a calculator for this one.

==>Save 6 months of take home pay<==

So if you bring home $5,000 per month after taxes and deductions aim to keep $30,000 in cash.

Yes, that $30,000 could be invested and you could put in the market and get filthy rich (over several decades).

Resist that temptation.  There will be time for that later.

For now keep that 6 months of income in your favorite online savings account.  It is there strictly for large emergencies.

A great place to save your emergency fund is in an online savings account.

The bottom line is don’t base how much you save on my advice, or advice from anyone else.  Base it on what amount makes you sleep good at night, or what amount your partner is comfortable with.

Just remember, the talking heads on television and radio are not the ones who have to pay for your emergencies – you do.

emergency-funds

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2 comments

  1. One of the things that I struggled with initially was how much cash to have for an emergency. It wasn’t until I actually had an emergency that things changed. So now I try to keep enough cash that I can buy a new car since, when my last car died on me, I was in a lurch and I promised myself I wouldn’t go back into that position.

    • @Mustard Seed Money: “Never going back” is often the motivation for many smart financial decisions. I feel the same way about accumulating bad debt.

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