Every finance expert would tell you that you should have three to six months of savings in your emergency fund. It has become a standard recommendation, and everyone is trying to meet up. The question you should really ask yourself is ‘how much should I have in my emergency fund?’
While it is always good to save, letting your money lay somewhere in your savings account isn’t such a good idea.
An emergency fund is kept in order to cover unforeseen expenses. For instance, a medical emergency that prevents you from working may require you to spend a large amount of money which you haven’t budgeted in your monthly expenses. The size of your emergency fund depends on how much you earn and what kind of emergencies you plan for.
What happens when you overfund your emergency wallet?
When you put too much in your emergency fund, you miss out on a lot! There are a lot of places you can put some money that would yield more interest.
One of such places is your 401k. Contributing to your retirement is one of the best ways you can spend such money.
Other ways your money can be better-utilized is by paying off debt and investing in stocks or real estate.
According to NerdWallet in a survey that was conducted in 2015, one in five partners has no saving goals. Overfunding your wallet simply means you’re putting your money in the wrong place. Saving blindly would result in fewer earnings and a high probability that you spend on the wrong thing.
To keep your earnings on the higher end, save only as much as you need for emergency cases. With the rest of the money, you can get more in return.
How much should I have in my emergency fund? – For low-income earners
Saving three to six months’ expenses in your emergency fund may not be feasible for low-income earners. Some people who earn about $40,000 per month would not be able to generate such amount in a short time. Does that mean you become helpless in emergency situations?
A new report titled Rules of Thumb in Household Saving Decisions, written by Emily Gallagher and Jorge Sabat has shown that you don’t actually need so much in your emergency fund.
According to their findings, you need a minimum of $2,467 in your emergency fund. This is far less than the common rule of thumb, as you only need roughly 1 month of income.
Even Dave Ramsey, the popular financial personality advises his followers to have only $1000 in their emergency fund.
Emily and Jorge’s report also mentioned that households without health insurance and those led by single mothers should save an extra $1000.
They emphasized that their report is the minimum and should not be interpreted as optimal saving levels. You can keep adding more to it depending on how much you think you will need whenever emergencies arise.
How to calculate how much you should have in your emergency fund
The amount of money you need in your emergency fund is particular to every individual. The common three-to-six months rule talks about expenses and not income. Even with that, reaching this level is difficult for many, even if you’re earning an average income.
Factors that help you determine how much you have in your emergency fund include how much you make, how diversified your sources of income are, and how many earners you have in your home amongst others.
To calculate how much you need, examine your expenses by planning a budget. Organize your spending into what you need and what you want. Necessary items include electricity, water, heat, mortgage, food, health care costs, insurance, and debts payment. Sum up all you plan to use for each of these and multiply it by the number of months you want to cover.
Should I increase or reduce my emergency fund?
Increasing or reducing how much you put into your emergency fund totally depends on you. With the scenarios shown below, we would help you make such decisions.
You might consider saving more when-
- Your income is irregular – If you don’t receive money every time, having extra saved whenever you do is very important. This ensures you don’t go broke and end up increasing your credit card debt.
- You risk losing your job – Some industries have a high turnover rate, and you don’t know when you’re going to get fired. When you’re at high risk of losing your job, it is better to save towards that time when the job is finally taken away.
- You’re the sole income earner – When you have the sole responsibility of providing for the family, having extra saved is a good idea.
You can decide to save less when –
- You have other funding sources – If emergency funds are not your only savings, then you can save less in this account.
- Your job is secure – If you’re unlikely to lose your job any time soon, and you’re quite sure of it, you can decide to save less.
If you need to increase your emergency fund and your income is low, you should get side gigs to provide you with additional income. For some people, this side gig ends up becoming their main source of income. You may be lucky.
When do I use my emergency fund?
Loss of jobs come to most people’s minds when they think of the right time to use their emergency fund.
Although emergency savings would help you cover your expenses when you lose your job, that is not its sole purpose.
Things happen which you don’t plan for. As the name goes, emergency funds are meant to help you stand on your feet when life hits you with its worst. An emergency fund shouldn’t be used for expenses like vacations. If you need to use out of your emergency fund for situations like this, make sure you have the money replaced as soon as possible.
Whenever you ask yourself the question ‘how much should I have in my emergency fund?’ here’s what you should know.
Your emergency fund shouldn’t be your sole savings. It is only there to keep you from falling in cases where your monthly budget can’t cover the expenses. For example, if you lose your job or your car breaks down.
Irrespective of how much you earn monthly, it is advisable to avoid throwing most of your earnings in your emergency fund. Investing your money in profitable ventures, and getting an IRA or 401k savings account are better ways to use your money.