QuinceMedia / Pixabay
Here’s how to determine what’s right for you
While most people are aware that emergency funds are an essential part of a stable financial life, there is a lot of confusion about just how significant a workable emergency fund can be. It doesn’t help that financial planners have varying advice about this too. Some recommend only a few months of salary savings, while others suggest as much as a year.
What is the actual “goldilocks” amount for an emergency fund? One that’s not too big and not too small? We’ve got some information that can help you find the right answer for you.
Ways that an emergency fund helps
Before trying to determine a goal amount for an emergency fund, it might be helpful to consider how it is used. One of the most common perceptions for an emergency fund is that it can be used to pay rent and other bills in the event that household income levels decrease significantly or disappear.
While it is possible that unemployment insurance or a purchased short or long term disability program can help out, there might be situations where these funds aren’t available. In such cases, emergency savings can keep you from having to turn to credit cards, loans from retirement funds, or other expensive sources to stay afloat.
In addition to helping out in case of income loss, emergency funds can do other things to support your financial health. The fund is where you can turn to for more significant, unexpected expenses like medical bills, household repairs, and car bills. While others may turn to higher-interest sources for these loans, if you’ve got an emergency fund, you won’t have to.
The right size for your emergency fund
So, what should the right size for an emergency fund actually be? A large number of financial pros recommend something that is in the range of between three months of monthly earnings for those with stable employment and six months of monthly earnings for those who are doing less stable, contract work.
Celebrity financial advisor Suze Orman has a different take. She can’t see how three months of savings are enough to get anyone through the challenges of finding a job during unemployment or dealing with a serious medical crisis. She suggests that to maintain a reasonable degree of financial stability, households maintain eight to twelve months of savings. In her words:
“Go back to 2007…do you think it took just three months to find a new job? Think it took six months to find a job?”
What is the right size for an emergency fund for you? This is a profoundly personal question connected to your risk tolerance, your employment stability, your budget, and your outlook on life. To come up with an answer, give it some serious thought over time and consult with a financial professional you trust and who knows you.
Managing your emergency fund responsibly
“As long as you have the money, it may as well work harder for you.”
Once you have a bit of savings, there are ways to manage it so that you can preserve and possibly even grow your account a bit. As long as you have the money, it may as well work harder for you, right?.
How is this accomplished? Consider putting your money in an easy to access savings account that you can withdraw from without penalty. If you’re not sure where to start, look for a list of bank accounts with higher levels of interest or easily accessible brokerage options. Again, your financial advisor may be able to point you to some strong options in those areas.
A deeper dive – Related reading from the 101:
- 6 steps to begin easy investing | Finance 101
Want to learn about investing? Start here.
- Keep your nest egg on track with a retirement savings calculator | Finance 101
Here’s a great way to make sure you’re ready for retirement.