Most financial experts recommend an emergency fund equal to the size of three to six months of your salary. That’s not a bad rule of thumb, but a better way to base the size of your emergency fund is on the amount you normally spend, not your income.
An emergency fund should contain enough money to hold you over financially if you should lose your job or otherwise become unable to earn an income. Emergency funds are also useful when you have unexpected expenses such as large medical expenses, unexpected travel, or major car or home repairs that cost more than you budgeted for. Let’s take a look at how you can determine how much money you should set aside in your emergency fund.
Calculate Your Monthly Expenses
First, sit down and figure out how much you pay out in an average month. Only count expenses that are absolutely necessary, so for the purpose of figuring out how much money you need in your emergency fund, you can ignore almost anything in your budget that isn’t required. For example, you may be able to temporarily postpone or eliminate expenses such as a vacation fund, cable television bill, gym membership, dining out regularly, entertainment, clothing expenses, and some other items.
Make a list of your monthly bills for your home, including rent or mortgage and utilities. Include transportation expenses, insurance, debt payments, groceries, medical expenses, tuition, taxes child care, and other fixed expenses.
Once you have calculated your required monthly expenses, you need to decide how many months you want to have saved in your emergency fund to cover those expenses if you should lose your job.
Number of Months Emergency Fund Should Cover
While experts claim three to six months is necessary, each emergency is different. Many military members have very stable job situations, but that isn’t always the case for some members who are forced out of the service through a force reduction, or for many of the millions of veterans who are hit with layoffs and reductions in the civilian work force. Because each situation is unique, it’s hard to say how long it might take you to find financial security, especially in a struggling economy like we have now.
Keep in mind, if you have a spouse with an income – you don’t need as much money in an emergency fund as someone who is single or the only source of income for the family. You and your spouse (unless you work in the same place!) are unlikely to both lose your jobs at the exact same time.
If you receive money from a trust fund, alimony, child support, self employment income, or other sources of income in addition to your job, you can modify the amount of your emergency fund by that much money. So if you receive $200 a week in child support payments, you can reduce your monthly expenses by $200 per week (since you know you have that much coming in each week) and save less in your emergency fund.
If you have a CD ladder or other type of investment which is fairly liquid and could be removed if necessary, you may be able to keep a smaller emergency fund as well.
Don’t consider your 401(k) or IRA type accounts as money you can access, because they are not easily turned into cash and are much too expensive to withdraw before you reach retirement age.
At a bare minimum, an emergency fund equal to your minimum monthly expenses for three months should hold you over long enough to find work (even if it pays less than your current job), and help you transition should you have to reduce your expenses to match your new income.