How Much of an Emergency Fund Do You Need?

In case you haven’t heard, you need an emergency fund, and you need it yesterday. In the good times, we could rely on home equity loans and credit cards to tide us through the bad times. Now, HELOCs are gone or shrinking and credit card issuers are reducing credit limits. Unless you want to borrow against your 401K (which has probably also shrunk), you need an emergency fund. But just how much should you save?

Three Month Emergency Fund vs. Six Month Emergency Fund
Most experts recommend six months of living expenses (not income). I generally agree with this assessment. However, there are situations where three months may be enough to get you by. If you or your spouse is a healthcare provider, K-12 teacher, or public safety officer, then you may only need three months of living expenses. Even in a deep recession, we’ll still need doctors, nurses, teachers, cops, and firefighters.

If you or your spouse work in a risky field, you might want to save nine months’ living expenses. By risky I mean: auto industry, financial services, real estate, and retail. If you haven’t already lost your job, chances are good you will soon. Even if you keep your job, you may have to take a pay cut. Can you live on less?

Some experts say that any family with two working spouses needs at least six months, on the theory that you need both incomes to survive and its harder to replace one of those jobs than it is for a non-working spouse to get a job for the first time. I don’t entirely see the logic in this argument. If you both work, hopefully one of you will keep your job. If only one of you works, then your sole source of income could vanish. It’s not easy for a non-working spouse to just jump back into the workforce in a severe downturn, or even if good times.

What’s the Minimum?
The bare minimum recommended by Dave Ramsey is $1,000, but that’s not even enough to cover the mortgage for many people. Save up at least one month’s living expenses right away. Stop contributing to your retirement fund and paying down debt if you have to, but make sure you can cover at least a month. Even if your job is safe, you never know when you’ll need to take family leave due to illness.

What If You Can’t Save?
You can. You can save up enough for basic living expenses. Take a look at your monthly spending and pare it down to the ultra-basics:

  • Housing (rent, mortgage)
  • Transportation (gas, insurance, metro card, car payments)
  • Healthcare (necessary prescriptions)
  • Utilities (water, power, gas, basic telephone)
  • Food (a minimalist diet, no frills)
  • Child support
  • Tuition

You can cancel subscriptions to cable, movie rental services, the gym, magazines, the newspaper, and anything else if the situation gets bad. Just make sure you can cover your “monthly nut” for one month. Once you’ve got that, try to save up two months, and then three.

It seems like a lot of money now, but it won’t seem like much if you suddenly need to live off of it. It’s also not just reserved for a job loss. I would avoid dipping into it in the current economy, but you can use it for emergency major car repairs, emergency medical bills, and other major emergencies that require a lot of cash, quickly when times are flush.

You have nothing to lose by saving an emergency fund in a nice, safe, boring savings account. Do it now to get your new year started right and give yourself a little financial peace of mind.

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