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[Prefer to listen? You can find a podcast version of this article here: E151: How Big Should My Emergency Fund Be?]

Not a flashy topic, but it’s an important and interesting one.

Emergency funds are a financial safety net for unexpected emergencies or expenses. They may be used if you suddenly have no income for an extended period of time or if you have larger expenses you have not been planning for like suddenly needing a new car or refrigerator.

We’ve all heard:

“Life is what happens when you are busy making other plans.”

Your emergency savings is the cushion to what life throws at you.

If you Google “how much money you should save in your emergency savings” and you’ll see multiple versions of the answer:

You should have at least 3 to 6 months of living expenses in your emergency savings account.

While that’s a great target, the answer is much more nuanced and there are many factors that should be taken into consideration. It’s a starting point, but it’s not a one-size-fits-all solution.

Before we dive too deep into how to figure out how much money you should have in your emergency fund, let’s get a few definitions out of the way.

Bucket - a goal-oriented way of saving money that earmarks your funds for specific purposes. Some people prefer to have separate savings accounts for their buckets. While others have the discipline and tools to use one account that sets aside money for specific purposes. Your banking institution may have “buckets” available for your accounts. Ally, Novo, and (insert another option or two) have this perk.

Deductible - a specified amount of money an insured person must pay before an insurance company will pay a claim.

Discretionary expenses - optional expenses like vacations, entertainment, and large purchases such as jet skis, a boat, or remodeling

Elimination period - how long before a policy kicks in and starts paying a benefit.

Emergency fund - a savings account or “bucket” of money designed to be a buffer between you and unexpected expenses that come up that are outside of your typical budgeting.

General savings - money over and above your emergency fund.

Living expenses - what it takes to operate your household.

Liquid assets - cash or any asset that can be easily converted into cash quickly

Roth IRA - contributions are after-tax dollars and your money grows tax-free

To start off, you need to figure out what your living expenses are.

This includes things like:

• Mortgage/rent
• Insurance premiums
• Medical
• Home/renters
• Automobile
• Disability
• Etc.
• Utilities
• Gas
• Electric
• Water
• Garbage
• Sewage
• Internet/cable
• Streaming services
• Medical costs
• Medications
• Co-pays
• Childcare
• Transportation
• Car payment
• Gasoline
• Other transportation costs
• Groceries

Your living expenses do not include any discretionary expenses you may have during ideal times.

Next, let’s look at what factors to consider to customize your financial goals for an emergency fund. While we look at these factors, don’t feel overwhelmed. This is not something that most people can snap their fingers and have their target. This will be a gradual process but the accumulation of your small actions will help you meet your emergency fund goal.

Stability of Income

This is a big one. What is the status of your current employment? Are you a contract or gig worker or do you have a stable position at a company that is well established?

Is your career or profession in demand? If you were to be laid off from your current position, how long would you expect to take before you find a new position?

How many people are contributing to your household income? Single income households may need a larger buffer than a dual income household. If you have a partner that contributes to your household income, you may be able to rely on one income for a long period of time.

Stability of Expenses

Do you have a newer or older home? Newer homes may have less expenses for upkeep than an older home.

Do you have a newer or older car? Older cars may have more frequent repairs needed to maintain its usability.

Debt

Debt adds risk. If you have little debt, you may consider a smaller buffer in your emergency fund. Is your debt larger? High payments and high balances that need to be paid off are clear indications of needing a larger emergency fund.

Health

We can never say “I’m healthy and I’m going to remain healthy.”

What is your health like? What is the health of your family members?

Health can change at a moment's notice but there are some indications and we can look at the overall health history of your family

Is your family generally trending on the healthy side? No chronic illness or serious medical conditions?

If you or members of your family live with illness or on-going health conditions that could lead to more serious issues, that’s an indication to lean towards having a higher emergency fund.

High Risk Activities

Do you engage in high risk activities? Some common high-risk activities include but is not limited to:

• Tobacco use
• High alcohol consumption and binge-drinking
• Illegal substance use
• Dangerous driving
• Rock climbing, rappelling
• Sports like kickboxing, bull riding, base jumping
• Caving or spelunking
• Skydiving and base jumping
• BMX, motocross, off-road racing, and drag racing

High risk activities increase your risks and should be an indication of building a larger emergency fund.

Dependents

Do you have children, parents, pets or any other people that you support?

More dependents = more exposure. You may want to consider a larger buffer for your savings.

Kids can make poor life decisions. They engage in high-risk activities, and can fall out of a tree or break a leg.

Don’t forget about any fur babies in your life and the potential risk of unexpected vet bills, the cost of any changes in diet, or providing care for your pets.

These factors should be included in your decision on how large your emergency fund should be.

Financial Support Network

Do you have lots of family that live nearby that you could lean on in a pinch? If you have a large support network nearby that can help in a variety of ways, like pitching in for childcare or grabbing a roll or two of toilet paper from, you may not need as large of an emergency fund. Are you part of a family that gets together to share a meal once a week or more? That means your expenses for groceries can be less.

Or are you in a place where you don’t have very many friends and family that live near you that could help you. If your financial support network is pretty minimal, you should consider a larger buffer because you need to self-support in a stronger way.

Elimination Periods on Disability Insurance

My own rule of thumb is to generally have at least enough to match up with the elimination period of a disability insurance policy. Let’s say your disability insurance has a 90 day elimination period, it will take 3 months before your disability policy kicks in to cover some or all of your income.

Sometimes elimination periods can be 6 months or more. In that case, you would want to have 6 months of expenses in your emergency fund to cover the period before your benefits apply.

Creating a target for your emergency fund that aligns with your elimination periods is ideal.

Insurance Deductibles

Your home, medical, and automobile insurance likely have deductibles. The higher your deductibles are the more of an argument there is to have a larger emergency fund to cover those if something happens.

It would be more appropriate to have a slightly lower emergency fund if your deductible is lower.

But if you have a robust emergency fund, it may be more appropriate to have a higher deductible that you are able to absorb in the case of an event and you could benefit from a lower premium. You then have additional money to add to your savings.

You can look at this in either direction. My deductibles are high, therefore, I should have a higher emergency fund but you can also say my emergency fund is well funded, therefore, I can have higher deductibles. It kind of goes both ways.

Other Liquid Investments

In general, it is not ideal to invest your emergency fund. You can invest part of your emergency fund safely and sensibly if it makes sense for your situation.

Side note: Let’s say your target emergency fund is 6 months but you have 3 months in cash and 3 months in a conservative low-risk investment, that’s not necessarily a bad thing. A little bit could be at risk, but if it’s in conservative investments, they are ideally not going to plummet as much. You are not going to see huge swings and you might make a little bit from it when the investments do well.

You might also consider I Bonds as part of your emergency fund.

Let’s say you have a 6 month target for your emergency fund and you have 4 months in cash but you have hundreds of thousands of dollars in Roth IRAs and taxable brokerage accounts. I would consider those liquid investments that are enough of a backup that you could get away having less cash in your emergency fund. While we don’t want to pull investments from the market, they do act as safety nets.

If you have zero in investments or it’s all locked up in pre-tax 401k and it’s not very accessible, you want more cash and higher levels of emergency fund balance.

Quick summary of factors to consider:

Indicators for a higher emergency fund

• Unstable income
• Profession is not in high demand
• Older home
• Older car
• High debt
• Poorer health
• Participate in high-risk activities
• More dependents
• Small financial support network
• Long elimination periods for disability insurance or no disability insurance
• High deductibles
• Low balance of liquid assets

Indicators for a lower emergency fund

• Stable and consistent income
• High demand profession/career
• Newer home
• Newer car
• Low or no debt
• Exceptional health
• Large, close financial support network
• Short elimination periods on disability policy
• Lower deductibles
• High balance of liquid investments
• Where do you end up with your emergency fund?
• Well, it depends. I can’t say specifically without talking to you more in depth and learning more details. [insert CTA message/form/email?]
• I will say it’s not a bad or uncommon thing to have an emergency fund that is 9-12 months or even over a year.
• You may feel like you want to have that stability because
• Your income is unstable.
• You are a business owner with irregular income.
• You have other high-risk factors in your life.
• You just want to have that psychological buffer to lower your stress.

All of that is valid. It’s OK to have a year in the bank.

Can you go overboard? Potentially. If you have 3 years of cash in the bank and 2 stable incomes in your home, that might be overkill and we can chat about investing some of that.

Also say you want to go lower than 3 months, I’m not going to say that’s necessarily wrong for you (although that would be atypically low).

However, I generally see around a 6 month mark being pretty ideal. Six months, give or take, is more commonly what I see as reasonable for most people.

Think through those options. Think through those indicators, characteristics of your financial life, look at your risk factors, and different scenarios. This ideally will help you customize your emergency fund for your specific situation.

The rule of thumb is 3-6 months, but like most rules of thumb, it doesn’t always lead to a one-size-fits-all, you want to tailor it to your life.

Most of all, you should take action. Even if you can’t quickly get to your target savings, small steps will compound over time and lead you in the direction you want to go.

• Saving $20 a week = $2,080 in 2 years.
• Saving $50 a week = $5,200 in 2 years.
• Saving $100 a week = $10,400 in 2 years.

The goal isn’t to do this overnight. It’s to create a financial habit that will reduce your stress and increase your financial stability in the case of emergencies. You can do this a little at a time if you need to.

A properly-funded emergency fund is a great way to provide a buffer against the twists and turns life may throw at you.