During my last book giveaway, a couple of readers expressed interest in a new post on emergency funds. They wanted to know how to know when your emergency fund is big enough. I haven’t covered this specifically in detail before, but I did cover emergency fund basics and how to know when your emergency fund is too big. Both are good primers on this subject. Today I’ll try and answer the question, “how do I know if my e-fund is big enough?”
What is an Emergency Fund?
If you didn’t visit the links above, you may be clueless as to what exactly an emergency fund is. And defining it is a good place to start if we’re going to be deciding how big it should be. In my opinion, an emergency fund is money set aside to be used only in the case of a life emergency. Think of it as a small self-insurance policy.
A last minute vacation to Vegas isn’t an emergency. An emergency is an unexpected and required event / happening that you’re unable to pay for with your regular monthly income. The point of having a special fund setup to cover this expense is so that you won’t have to go into debt to cover the costs. You’ll be able to pay it off immediately, or support yourself over a few months in the case of a job loss.
So, how do you know if your emergency fund is big enough?
The first thing I’d say is, if you have to ask, odds are it isn’t big enough. 
I know I’m not going to get away with that easy answer though. So what I will do is try and give you some points to think about to give you confidence in your emergency funds. After all, I’m not going to be there to bail you out.
Know the Rule of Thumb – Most money experts will tell you that you need anywhere from 3 to 6 months worth of expenses in liquid savings (i.e. cash). If you’re unsure of how to calculate that number, or if you did calculate it and it didn’t give you warm and fuzzy feelings, keep reading.
The reason the 3-6 rule is used is because for the typical family that’s enough to help you get by for a bit if you lose your job. It also ends up being enough to help you cover unexpected medical bills, car repairs, etc. for the insured.
A great location to keep big emergency funds (>$5,000) is with EverBank. They pay one of the highest interest rates.
Know Your Monthly Expenses – If you’re going to use the 3-6 months expenses rule, you’ll need to determine what that is. The quickest way to do that is to get online and view the last 6 months of data from you bank. Use that data to determine the total average monthly spending over the last 6 months. Multiply that average by 3, 4, 5, and 6 months. The other factors listed below are going to help you determine which of these numbers (3x, 4x, 5x, or 6x) to use as a basis for your emergency fund.
Know Your Insurance Deductibles – A job loss isn’t the only type of emergency you could experience. Something could happen to your car, your house, or the health of someone in your family. Do you know how much your insurance company is going to cover? Are there large deductibles on your plans? Someone with a $5,000 deductible and a catastrophe health insurance plan is going to need a bigger emergency fund than someone with a premium plan who’s deductible is in the $100s. Based on what you find out here, you may be in need of a 6 months e-fund vs the 3 month variety.
Know Where You’re Not Insured – If you actually go without insurance for some area of your life, consider what an emergency in that area would cost you. Bump your emergency fund up based on what you have uninsured. Those without health insurance should really have a huge emergency fund to help cover those unexpected medical bills.
Know Your Assets – If you’re a one car family, unless you live in the city, you are highly dependent on that car (asset). If that car needed a $2,500 repair, you’d have no choice but to spend the money to repair it. Likewise with your home. If your home is old and in need of constant repair, you’re emergency fund will need to trend higher to be able to cover those repairs.
Know Your Job Market - Are you the sole bread-winner in the family? How confident are you that you could get another job a few weeks or months after you’ve been laid off? If you think it would take more than a few months, because (a) your industry is in bad shape, or (b) you aren’t that marketable (for whatever reason), then consider bumping your e-fund number up above the 6 month mark. Keep going until you feel comfortable with the number.
Final Thoughts
So where does that put your emergency fund? I think if you start with the 3 month rule and then bump that up based on the risk involved in the other areas I listed you can get pretty close to your actual required emergency fund. When in doubt, just strive to make your emergency fund big enough to cover you for 6 months of income instead of expenses. That’s a very conservative number and would put you way ahead of most other savers.
If you’ve decided that your emergency fund could use a boost, don’t stop now. Take the next step and start saving more today. Read the Best Way I’ve Found to Truly Save Money.
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There are many ways to calculate your emergency fund. Do you take the average expenses over a certain number of months? Or, knowing a financial crisis will curb discretionary spending, do you calculate 3-6 months worth of minimal expenses (mandatory monthly expenses, food, utilities)? Are student loans calculated into the decision if you can have them deferred? Should any unemployment checks factor into your decision?
The more “factors” you decide to apply to decrease your necessary monthly expenses, the longer of a term I think you’d need as an Emergency Fund. If you take little to none of the “factors” (as in your example of taking all expenses each month), then I would lean towards the lighter end of the 3-6 months.
Great topic, PT. It provides lots of food-for-thought that’s relevant in our financial lives.
In this economy, I think people are finding that 3-6 months is not enough. I am thrilled that we have been slowly building our emergency fund and at the present time, we’ve endured the first eight months of unemployment and are still debt free (besides the house). Has it been a character building opportunity for us? Absolutely! But has it devastated us? Thankfully, with years of living under our means and getting prepared for this very time, no.
Now ask me in a few more months if our situation hasn’t changed…
I see the light at the end of the tunnel, I hope.
Good point, Jen. 3-6 may not be enough for those in high unemployment areas, or for those in certain industries right now. Do you think you’d be open to a move or career change if things don’t improve?
Make sure the emergencies are small enough, that’s a good idea too!
A percentage of your income should be put into your emergency fund lets say 10% or whatever is reasonable. In my view it should be more than what you expect you will need if an emergency arises. In the end whatever is not used will be your savings.