How much to put into your emergency fund

How much should be in your emergency fund?

Emergency fund is a little or a lot of money stashed away for when your leg slips. I am yet to find a better explanation, so if you have one, pop it into the comments field. This post will be all about figuring out how much you might want to keep in your emergency fund.

Dave Ramsey, the guy who popularised the term with the masses, and I am counting myself as masses, says that you should start with $1000. If you don’t have any consumer debt, that $1000 should be upgraded to an equivalent of 3 – 6 months’ worth of expenses. That’s a rather broad range if you ask me.  Over the last few weeks I asked my family and friends some greatly insensitive questions and based on their responses I came up with a little decision tree to help you (and me) figure out a specific range.

One thing to remember is that we are speaking about the equivalent of expenses, not equivalent of income which will be placed in your emergency fund. This means that if you make $6000 per month but only spend $2000, you will calculate your emergency fund using the $2000 per month cost of living figure.

The very first consideration which will feed into the decision tree is about the income. Is the income you are making stable? This is a remarkably broad question though, and can be translated into:

  • Is my job or business income secure?
  • Is the income I receive if I don’t work /run a business stable? Such income can be a state pension, rent income or any other source of money coming your way
  • Is my income diversified in a way that I always have some money coming in?

Following from the answer to this first question, the next consideration would be on who your income supports. Is it just you? Do you have a spouse and children reliant on the money you make? Do you support elderly parents? Extended family? A pet? I personally find this consideration a little scary as it is a clear indicator of who in your life would suffer if you are in some way irresponsible, unfortunate or just unprepared financially.

The next thing you will need to consider is whether your income can be easily replaced. If you run a business and it fails, can you spin a new business quickly? If you are employed and you are let off, can you find a suitable job promptly? If your income comes from other sources such as rental, if your property becomes vacant, are you able to re-let it quickly? Be realistic here. I always thought about my trade being fairly easy to find jobs in, and yet my own last job move took months to finalise.

Finally, consider insurance. Do you have relevant insurances in place? If you live in the US and suddenly find yourself jobless, what will need to happen to ensure you still have healthcare provided for you? If the worst happens and you are living behind a dependent family, do you have life insurance? Would you want to consider income replacement insurance if your trade is unique?

The above considerations are not light, but once you give them some consideration, deciding the right amount of emergency funds for you will be fairly easy.

Let’s start with the first question. Is your income stable? Is it secure or are you in a company that might be folding?

If your income is stable, the decision tree is a little bit easier and looks something like this:

Untitled Diagram

 

 

My own circumstances would take me through the following journey.

Is my income stable? Yes

Do I have a family or anybody else relying on my income? No

Can I find a new source of income easily? Apparently not.

My journey would end at 6 months’ worth of emergency fund which, based on my current budget equates to right around £9,600.

If your income is somewhat unstable, the journey becomes only slightly more involved and looks like this:

Untitled Diagram (1).jpg

If we were to change the assumption about my income and take that it is quite a bit more shakey, my journey would be:

Is my income stable? No

Can I find a new source of income easily? No

Do I have a family or anybody else relying on my income? No

My outcome would be the same: 6 months worth of expenses. However, if we changed my job to something a little easier to source, I’d only need around 3 months.

The above is definitely not a perfect science because circumstances change, so take it with a pinch of salt. And since it’s your life always err on the side of caution and slap extra couple of months on top of what this diagram tells you. In my own circumstances, I have opted for 8 months worth of emergency fund instead of 6.

I sincerely hope this article was useful – do let me know!

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