I am happy to answer reader questions on a regular basis. Recently, I received this question:
I know I’m supposed to have an emergency fund. But how much do I need in there?
Like so much in personal finances, the answer to that question has a lot to do with your own financial situation, as well as your particular goals and plans for the future. The rule of thumb answer is to have between three and six months’ worth of expenses saved up in your emergency fund. Some personal finances experts, like Dave Ramsey, suggest that you have a $1,000 immediate emergency fund available (for unexpected expenses like car repairs), while building a more long-term emergency fund of the standard three to six months.
At Consumerism Commentary, there is a great post that encourages you to ask the following questions of yourself as you debate whether to focus on the three months or to try for the six months:
- What are your monthly expenses?
- How stable is your income?
- Is your skill set in high demand? If you lost your job, how easy would it be to find another one?
- Are you willing to work at a low-skill, low-wage job to help keep you afloat until you find something else?
- Can you reduce your monthly expenses if something untoward happens?
- Would moving make sense to help you find another job?
All of the issues affect how large of an emergency fund you need. If you are willing to supplement with another job while you look for something more suitable to your qualifications, then your emergency fund does not need to be so large. If, however, you are concerned about getting back into your field, and you want to devote your time to the job search, a larger emergency fund might be a good idea. Here are some other things you might consider if you hit an emergency and need some additional funds:
- Supplement with unemployment benefits if you are actively looking for a job.
- Turn to friends and family.
- Consider selling some of your stuff.
- If you have investments not attached to your retirement account, consider cashing them in (but watch out for the tax hit).
- Avoid borrowing against your retirement plan if at all possible. Save this as a last resort.
Personally, I have a credit card available for when I get in tight spots and need money immediately (sometimes it’s hard to get to the bank). Of course, this means that I have to pay interest if I can’t immediately pay back the credit card balance. I also have a high yielding savings account for an emergency fund. This money can be used to pay off the credit card balance if needed, to help me avoid interest. Of course, it is important to replenish your emergency fund as soon as possible when you use it.
Our (mine and my husband’s) current goal is to get it to four months’ worth of expenses.
Next post, we will look at some tips for building an emergency fund.