How Much Money Does Your Emergency Fund Really Need?
Emergencies are always waiting to strike. It could be weather or a job loss. Your car could break down, or you could have an unexpected medical bill pop up. Regardless of the situation, having a stockpile of money to help you through these problems is extremely important. Not only will it help you weather these emergencies, but it will give you peace of mind that you can weather these emergencies. But how much money should you have saved? Well, that entirely depends on what your emergency fund is for.
Build Your Bare Bones Emergency Fund
The first step to building your emergency fund is to get $1,000. For high income people this should take a month or two. But for the majority of the country, building up $1,000 is a challenge. This is in fact so hard that 46% of Americans say they could not come up with $400 to cover an emergency. Now just think about how long it takes the average person to save $1,000.
This is what I call your “bare bones” or “baby” emergency fund. It will cover many emergencies such as a (small) medical bill or a flat tire. Having this amount of money should help you rest easier knowing that you can now tolerate some stuff happening. When people who are in over their heads financially show up onto r/personalfinance, the first set of actionable advice is to build this small emergency fund to help stop the debt cycle.
But this isn’t even close to being enough of an emergency for the average American. Compare yourself to the Average income of $38,000. Do you make more? If you do, $1,000 isn’t even in the same area code, it might not even be in the same state. You probably need to save significantly more to build you emergency fund, but how much more?
Assume The (Most Realistic) Worst Case Scenario
The point of your emergency fund is to help you weather emergencies. When you are assessing your emergency preparedness, you must consider the worst case scenario. When engineers build bridges, they must support a bridge full of tractor trailers while it is snowing 1 foot per hour. When software engineers design websites, they must assume high amounts of traffic when determining resources so the site site never goes down. Why? Because failure is not an option. When it comes to an emergency, you must design your safety net such that it will not fail. Failure means catastrophic repercussions.
This means you must look at the most realistic financial emergency that you can encounter, and dial it all the way up to 11. In general, these emergencies will be the same for most people. Here are a selected few:
- Job Loss
- Natural disaster
- Car repairs
- Broken iPhone / electronics
There are of course many other things that could happen, but these are the most common. Particularly the last one. People break their electronics all the time. Dropping your beloved MacBook Pro into the tub right after you get laid off would have absolutely catastrophic ramifications.
How Big Should Your Emergency Fund Be?
I asked people on Twitter how big their emergency fund are. I was extremely surprised by the results. To be fair, I didn’t know what the results would actually be so I was going to be surprised no matter what! What surprised me most is that 56% of voters have less than $10,000 in their emergency fund. This sound like a lot and it definitely is. But anyone who owns a home or has children knows that expenses can spike, and having less than $10,000 means you could be wiped out by having to replace a roof or braces.
Precursor for tomorrow’s blog post: How big is your emergency fund?
— Zero Day Finance (@zerodayfinance) June 14, 2017
To determine how big your emergency fund should be, I recommend taking the two most likely events on this list, and figuring out how much the combination of them would cost over a 3-12 month time period. I’ll use myself as an example. I am not concerned about natural disasters because I am pretty prepared (definitely not a prepper though). Besides, in the event of a terrible natural disaster, I’m not going to care about money. My car is still relatively new so I shouldn’t have any major repairs to complete, plus I have full coverage insurance. If I break my iPhone or electronics, that will only be about a $1,000 set back.
Losing my job and getting sick at the same time are what I need to plan for. This is probably the case for most people to be honest. These two, in combination, can be an extremely challenging emergency to deal with. When you lose your job, you must pay for your everyday spending from savings. Looking at my average spending, I usually come in at about $3,000 per month. In addition, losing my job means paying for COBRA which will cost me an additional $800 per month, bringing my total monthly spend to $3,800.
In addition, my out of pocket maximum is $1,500 per year (thanks to my high premium healthcare plan). When I “run” my model, I assume I must pay $1,500 in the first month and $0 thereafter. I personally want my emergency fund to cover 6 months of this emergency. From here, it is just math. My emergency fund must be $24,300! That is a ridiculous amount of money to save in an emergency fund. But is it?
This Is Ludicrous!
My emergency fund should be $24,300. That is an insane amount of money. In fact, you might say ludicrous. But let’s go back to my original parameters for an emergency fund. It must completely protect you in the event of an emergency. It must not fail. My emergency fund must cover 6 months of my regular expenses assuming that I lose my job right as I get sick. Consider how much money your family spends per year. Now cut that in half. That number probably falls closer to $24,300.
Once my emergency fund is that large, I know that I can comfortably weather being laid off and getting sick for an entire 6 months. That is plenty of time to get better and also look for a new job. But do I really need that much? I’d rather have that saved just in case, especially because of my risk tolerance.
Do you need that much? Maybe, maybe not. That entirely depends on you. If you have a family on a single income, you should have at least $25,000 and probably more. When I have a family with young children, I will bump up my emergency fund to at least $50,000 which will pay for an entire year of expenses and healthcare. If you are a young single person living at home, maybe $3,000 will do. Life’s always easier when you get to stay in the hotel of mom and dad for free, and your expenses will reflect that. The point is save enough to cover what you consider to be the gravest emergency that you may encounter. Peace of mind is so valuable. In fact, it is worth every penny.
How much do you have in your emergency fund? After reading this post, are you considering saving more? I’d really like to know.