Your boss just told you it’s your last day of work. Shell-shocked, you check your bank account. Does the amount make you feel like you have enough time to formulate a plan and get back on your feet? Or does it lead to a serious amount of financial stress?
Ask three financial experts “How much should my emergency fund be?” and you’ll probably end up with three different answers.
“There are a lot of rules of thumb out there,” said Ryan Frailich, a fee-only financial advisor and founder of Deliberate Finances, a New Orleans-based financial planning firm. “But what really works for you depends a ton on individual circumstances.”
Instead of latching onto a specific amount someone else thinks is right, Frailich said, you need to look at factors in your life to decide how much you actually need in your emergency fund.
You don’t need a fully-funded emergency account right now for success. In fact, the most important thing is to get started.
Natasha Rachel Smith, a personal finance expert at TopCashback.com, a website devoted to helping consumers earn money back when they shop online, suggested looking at what you can set aside regularly, rather than getting hung up on the final target. Too many people get stuck thinking about the goal and give up before really starting.
“To start, it’s about getting in the habit of respecting money more,” said Smith. “You want to save money and feel a sense of pride about what you have accomplished, even if you’re only adding a dollar a day.”
Smith recommended building up to your goal. “Start with $500 or $1,000. It’s a great foundation and can cover most one-time unexpected expenses.”
She said your initial emergency fund “seed” can come from gifts, a work bonus, or your tax refund. Then, look for ways to free up a little more each week. Start with a few dollars a week. When you are comfortable, add to the amount you contribute.
“Saving little by little each week will eventually add up without putting a strain on your budget,” Smith said.
Review your non-discretionary expenses
Your emergency fund doesn’t need to cover everything you spend money on, Frailich said. Instead, start with non-discretionary spending.
List what you absolutely have to cover each month, such as housing, insurance, utilities, groceries, and debt obligations. The list will help you figure out what should be covered in a month and provide you with a realistic idea of what you can cut in a pinch.
How stable is your income?
When you have a stable job, said Frailich, you don’t need to worry as much about an emergency fund. That’s also true if you work in a career field that’s in demand, as you might be able to find a new job faster.
“If you’re an entrepreneur, you need a much larger emergency fund,” Frailich said. “It depends on the industry and what stage your company is in, but I often tell entrepreneurs to shoot for a full year of expenses saved up.”
Look at your job situation and consider how high the risks of a layoff or other disruption are. Be realistic about your prospects for a new position if you do lose your job. The harder it is to find a new job, the bigger your emergency fund needs to be.
Do you rent or own your home?
As a renter, you might be able to get away with a smaller emergency fund. Frailich said that some renters can walk away from their housing to live with family or friends for a short period of time if needed.
“If you’re a homeowner, you need more in emergency funds because you don’t have the same flexibility,” said Frailich. “You’re also likely to incur large unexpected expenses, like a roof repair or new air conditioning unit. These things run through a small emergency fund in no time.”
He recommended taking into account your flexibility and ability to tap into other resources when setting an emergency fund goal. You might not need as big a fund as you thought.
What will help you sleep at night?
What really matters, according to Frailich, is what helps you sleep at night. Do you feel comfortable with three months’ worth of expenses saved? If you have smaller financial needs, and you feel like you could find a new job quickly, a smaller emergency fund might be adequate.
Someone else might not be comfortable with that amount. Maybe you worry that you would have a hard time getting a new job. Perhaps you are concerned about what happens if you get sick. The more worried you are about long-term problems, the bigger your emergency fund should be. You might feel more comfortable working toward nine months’ worth of savings.
How much should my emergency fund be?
For each person, the answer to this question will be different. However, you can answer the question for yourself by looking at your individual situation and setting an ultimate goal.
Don’t worry if your fully-funded emergency account goal is still a few years in the future. The important thing, said Smith, is to make sure you have some sort of cushion to reduce the impact of unexpected events and expenses. Even a couple thousand dollars in the bank is better than no money at all for emergencies.
Frailich emphasized the importance of evaluating your situation, toting up your resources, and making a plan to set aside money each month in an emergency account: “Think about it and make a plan, rather than just picking a rule out of thin air.”
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