Your emergency fund is the cash you have set aside in case of — you guessed it — an emergency.
Ideally, you’re storing this cash in a separate savings account, in order to draw a mental and logistical barrier between this money and your other savings, so you don’t accidentally spend it on a trip to Aruba or a comfy new mattress.
This money is specifically for emergency situations, like a medical emergency, a death in the family, or to cover your living expenses should you lose your job and income. “If you also have an investment portfolio, you don’t want to have to liquidate things at an inopportune time to raise a little money,” explains Jonathan Meaney, a certified financial planner. “It’s good to have some cash on hand that’s not exposed to the ups and downs of the market.”
But how much, exactly?
Emergency savings aren’t usually measured in terms of dollars — rather, it’s months of living expenses that money could cover. For that reason, everyone will have a different dollar amount, and everyone will have a different need.
The most basic emergency fund, for a healthy person without dependents who lives well within their means, is three months of living expenses.
“If you lost your job, you could presumably find another one within this window,” explains Meaney. “Although in the current job market, it’s been a bit of a challenge.”
Dual-income families, people with dependents, or individuals with variable or commission-based income might want to think more in terms of having at least six months of living expenses stored in their emergency savings.
Some experts even recommend that every person blow straight past three months, and sock away at least six months’ worth of savings no matter their situation.
Again, the amount of savings you need is highly personal. “What does your overhead look like? Are your only expenses every month your utilities, or do you also have a $US600 car note?” Meaney asks.
When calculating your month’s living expenses, you’ll want to include costs like your child’s tuition, any debt payments you need to make, or any other expenses you’d have to cover should your income be interrupted. The number you come up with shouldn’t be a surprise, if you know how much you’re spending every month. “You’re starting from your budget,” Meaney explains.
Single-income families, families with health problems, and older and/or retired people will most likely want more months’ worth of cash stored away — at least eight months, or even an entire year.
While no one expects an emergency, those who are bringing in less income or who are at a higher risk for some sort of upset (like older individuals) will want to make sure they have enough money to cover them for a considerable period of time, or a series of very large bills.
It may sound like a lot of money, but amassing your emergency fund is just like saving for a vacation or a new car: Set up a regular auto-deposit from your paycheck into your emergency fund, and let it grow quietly in the background, hopefully never to be needed.