A fully funded Emergency Fund is a cornerstone of financial security. But what exactly counts as “enough” saved?
Most financial gurus will suggest you have 3 to 6 months of essential expenses worth tucked away in a savings account. Is this amount realistic? More importantly, is it even necessary?
How much do you really need to save for emergencies?
An emergency fund is there to cover blips when things don’t go as planned: car repairs, emergency dental or medical bills It can also function to tide you over and pay your regular bills for months if you find yourself unable to work or terminated from your job. It does not exist to cover the times you accidentally spend $400 at the mall. Furthermore, a credit card or line of credit is not an appropriate Emergency Fund.
You should be saving your Emergency Fund in a high-interest savings account where it is easily accessible. I know it’s hard to keep money out of the stock market where it can earn a higher return, but you can currently get 2.30%* everyday interest with the EQ Bank Savings Plus account.
When it comes to how much you should have in your Emergency Fund, the number is intensely personal. My number is $10,000. This is enough to pay a few months rent before panic sets in. However, I’m also covered on all sides with proper insurance and multiple income streams. Your number might be different!
Why you can get away with a smaller emergency fund
There are a few different reasons you don’t need to leave a mountain of cash sitting in the bank. You should always have some savings set aside, but cultivating other safety nets can only do you good.
Furthermore, the less the chance you’ll need to touch your actual emergency fund, the more time it will have to grow!
You live well below your means
One of the best pieces of personal finance advice is to “mind the gap”. That is, the gap between your income and expenses. The larger this gap, the better equipped you are to deal with fluctuations in income and expenses.
Living well below your means gives you plenty of flexible spending dollars that can be redirected to cover an unexpected expense. If you’re underspending every month, a surprise bill can be absorbed without even needing to move anything around. Ideally, you should already have 5% to 10% of wiggle room in your monthly budget, but if you can increase this to 20% or 30% you’ll be even better off.
You have multiple sources of income
If you’re committed to side hustles and passive income streams, you have money coming from more than one source. If one income stream is lost, it can be readily and easily replaced by others already flowing into your bank account.
While losing your primary income source or your full-time job can throw a wrench in your plans, having side hustles that cover your essential expenses can get you through lean months. Ideally, you can pay your regular bills with these sources so you might not even need to tap into your Emergency Fund at all.
You have plenty of liquid assets
While all the money you have may not be earmarked for emergencies, it’s still there in case your emergency fund runs out. Things like vacation savings can be sacrificed for your rent should the need ever arise. However, you never want to use long-term assets, like your retirement fund, to cover regular expenses.
Why you need a big fat emergency fund
Despite all the advice above, a good case can be made for saving the traditional 3-6 months (or more!) of essential expenses in your emergency fund. Like most things in personal finance, what’s right for you depends on one hugely variable factor: you.
Only know what amount of money will make you feel “safe”. But if you want my opinion: more is almost always better. Below are the reasons why.
More than one emergency can happen at a time
Imagine this: a car accident costs you a huge repair bill plus an ambulance ride, and then puts you out of work for 3 months, during which time your water heater/furnace/whatever breaks down. Ouch!
The thing about unexpected expenses and emergencies is they are unexpected. We don’t really have a choice of having them happen only when we are fully prepared. It’s possible to hit a bad run of life events that rapidly deplete all your savings, and then something else happens on top of that. However, the more you have set aside, the better prepared you are against the unforeseen!
You might not be able to work
Life is tricky, and you can be diagnosed with a disability later rather than sooner. If you’re 25 years old, there’s a nearly 60% chance you’ll be disabled for 3 months or longer during your working lifetime.
One of your best defenses against unexpected illness or disability is being properly insured. Make sure you have both critical illness and disability insurance coverage. However, you’ll also need an Emergency Fund to carry you through interim when you’re waiting for insurance cheques to come through.
Sometimes it’s not about you
Sure your money can carry you through a hardship, but imagine you found yourself in the position where you needed to help a family member, like a sibling or an aging parent.
While there’s no obligation for you to help a loved one out of a mess, you might still choose to do so and your emergency fund might be your source of financial help. In the meantime, try to encourage those near & dear to you to develop their OWN emergency funds!).
Do you have any thoughts on the “right” amount to have in an emergency fund for yourself? Do you ever consider experiencing a disability or having support from a loved one when building your emergency fund?
This post was originally published January 10, 2011 under the title “Why Your Emergency Fund Needs to Be Smaller (and Larger!) Than You Think”