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So, should you have an emergency fund? Yes!
I would say that most people agree that you should have an emergency fund, but it’s one of those things that keeps getting put on the back burner. For me it took about 2-3 years from the time I actually started thinking about it to put one together. It is hard mentally to save for an emergency because you can’t help but think of all the other things you could be doing with the money. For me it’s been a challenge not to invest it, as I don’t like having money sit in a savings account making 2.0%. I want to buy some dividend stocks! I imagine that others have similar problems, but for them it might be a new tv, car, gadget or whatever is on their mind.
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The next difficulty is saving up the money. I was able to fund my emergency fund in when I sold my car, but for most people they will have to save up over time. Saving for an emergency fund can take a long time especially if you feel you need a large fund.
This brings us to the next problem. How do you figure out how much money should be in your emergency fund? This will be different for everyone as it is dependent on a number of factors. The general consensus seems to be that you should have enough to cover 3-6 months of your expenses. Some feel that this is not enough and that a year would be better. In some rare cases this might be appropriate, but personally I feel that a year is overdoing it.
So how do you figure out where you fit in the 3-6 month spectrum? Well you need to take a look at your life and ask yourself some questions.
1.) How stable is your job?
I have a government job, the salary is consistent and indexed to inflation. I feel that my job is pretty secure, and that I can expect a regular pay check for a long time. If you are self-employed, working on a contract basis or part-time, then you would want to consider a larger emergency fund. You may also want to consider the viability of the company you are working for.
2.) If you lost your job, how easy would it be to get employed again? Do you have a valuable skill set?
You want to ask these types of questions to try and figure out how long it would take to get another job if you lost yours. I have an accounting designation, a degree and a diploma. I should be able to get another job fairly quick with these credentials.
3.) Do you have kids, or other dependents?
The more people you have relying on you, means the more things that can go wrong. I’m in a relationship, but we have no kids or dependents, so a smaller fund is OK for me.
4.) What would you be comfortably with?
Peace of mind is something that is often left out when talking about emergency funds. For some they like having a larger safety net that they don’t necessarily need. I have no problems with this, I’d be more worried if your emergency fund consists of a line of credit and no actual savings.
5.) How’s your health?
I’m young and healthy, so not many worries here. If you have bad health then you should consider a larger emergency fund.
6.) What sort of financial obligations do you have?
If you have credit card debt, or other high interest debt then you should focus on paying that off first before starting an emergency fund. A mortgage would be the most common financial obligation I can think of. If you have a lot of years left on your mortgage then a larger fund should be considered so that you don’t default on your mortgage.
7.) How many other liquid assets do you have?
I don’t think you should put much weighting in this factor, but it can be considered, A lot of people feel that because they own their house they don’t need an emergency fund because they can just draw on the equity of their house. The idea of an emergency fund is to have access to money quickly. A house isn’t a liquid asset so this doesn’t count. What I’m talking about is having quick access to money. If you have a lot of investments then you know you can always use these in an emergency. I’d prefer not to do this as I don’t want to be in a position where I’m forced to sell an investment, especially if I loose money on the investment.
8.) How good are you at not spending money?
If you were in a crisis and had to live off of your emergency fund, would you be able to cut back on expenses and live on a bare minimum. Some people find if to difficult to revert to a lower standard of living. If you don’t think you can do it, then you’ll need a larger fund. I’ve been able to live well within my means for awhile now, so I’m confident this shouldn’t be a problem.
Based on all these factors I feel comfortable with an emergency fund that will cover my expenses for 3 months. Now all that’s left to do is to figure out how much you spend on a monthly basis. Because this is an emergency fund you should only be concerned with what you actually need to survive. If you are in an emergency it’s unlikely that you’d continue going out for dinner once a week, or buying a bunch of clothes. Figure out a reasonable level of expenses that you could live off of and then multiple it by the number of months. For me I figured that I could live off of $1,500 a month. So my emergency fund is $4,500. As time goes on I’ll likely be increasing this as various life stages: kids, houses, etc.
So, what do you think?
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