September 15th, 2020
How Much Should You Have in an Emergency Fund?
An emergency fund is money set aside for life’s unexpected events. As much as we try to avoid disasters, over time they are inevitable.
Having an adequate emergency fund provides a safety net as you go through life not knowing when a financial crisis may strike. Beyond the financial benefits, there are many simple psychological benefits that come from the peace of mind stemming from stable household finances.
The rule of thumb is to have three to six months of expenses saved up. However, you need to consider the number of family members you have and your insurance deductibles. The higher your deductibles and the more people dependent on you, whether that is parents, children, or other relatives, the more you will need to have in your emergency fund.
Financial stability also plays a role. The more financially stable you are, the less you need. For example, if you live in a two income household with steady jobs for the past several years in industries that are recession proof or resistant, you may lean more towards a lower emergency fund. Vice versa for the self-employed, has a commission based job, or chronic medical conditions.
It is also important to distinguish between necessary versus discretionary expenses. Necessary expenses include items such as utilities, housing, transportation costs, food, medical needs, debt payments, and child care. One commonly overlooked necessary expense to factor in are your insurance deductibles. Keep in mind your emergency fund is likely to be tapped into after a major event. So, do not forget to include how much your health insurance and homeowners insurance deductibles are when calculating your emergency fund needs. It is likely you will also max out your deductible at the same time.
While still valuable in their own way, expenses such as your monthly gym membership, travel funds, and Spotify subscription do not need to be factored in as they would be the first to be cut out during a financial emergency.
As far as where to hold the funds. A simple savings account will suffice. However, you may want to make sure this account is not too easily accessible so that you are not tempted to dip into this fund unless you really need it! So, opening a separate account helps create some separation between your emergency fund and daily checking account.