Like many people, you may be wondering what is an emergency fund and how much should you have in it. This is a great question to ask, and an important first step in creating your family’s financial plan.
How much to have in an emergency fund is a great question to ask, and an important first step in creating your family’s financial plan. It has also taken on increased importance in the era of Covid-19.
“Uncertainty is a key factor in deciding how much emergency fund to hold.”
An emergency fund is an amount of money that you wish to hold in your checking, savings, or other cash account to better protect yourself from unexpected financial events. We all hope that expensive repairs, medical bills, or loss of our income do not happen. However, if they do, working to create an emergency fund now will give you much greater financial flexibility and freedom in the future.
How much you should have is based on a variety of items related to your personal financial situation. On average, I recommend having between 3-6 months in expenses set aside in a separate cash account. For example, if your average spending is $5,000/month you would want to target between $15,000-$30,000. Two additional items to consider in deciding what amount is right for you is your amount of dedicated monthly expenses and degree of financial uncertainty.
Having higher dedicated, or fixed monthly costs may lead to a need to hold higher cash balances. Fixed monthly costs are the bills you do not have any control over paying. A few examples are expenses such as your mortgage, car payment, and student loans. Having larger payment amounts would likely necessitate a higher emergency fund. In general, families also tend to have higher fixed payments compared to single individuals.
Uncertainty is a key factor in deciding how much emergency fund to have. If you work in an industry or job that that has income variability or is tied to the strength of the economy, you may consider holding higher balances.
We all also face greater uncertainty than can be remembered in the wake of the coronavirus. If you are able to, now is a great time to build or expand your emergency fund. One way to do this is to save large windfalls immediately in a separate cash account. Take items like your stimulus checks or cash refunds and immediately set all or some of them aside. Most people are also spending less on dining out, entertainment, and other discretionary spending. Bank those savings now.
Using Your Fund
If you end up needing to use your emergency fund – that’s ok! That is why it was there in the first place. Just make replenishing it one of your top financial priorities.