One topic that I feel is approached as a cut and dry personal finance mantra is save up to 6-12 months of living expenses in your emergency fund. Perhaps I’m the only one struggling with this figure for various reasons, but I also think that individuals trying to correct their past financial mistakes see this as a road block to ever being able to move past their debt with this huge figure looming over their heads.
I like to view my emergency fund as just that; money to be used in case of an emergency. When I think of an emergency, I don’t think of losing my job (I’ll explain this in a moment), instead I think of an unexpected car repair, vet bill, or insurance premium. One reason I view these items as “emergencies” is they are truly unexpected. Here are a few “emergencies” I’ve encountered over the past year:
- Vet bill – Last summer I casually switched cat food on my cats. That equated to a $400 vet bill. It wasn’t an expected expense, so I used a portion of my emergency fund to pay the bill.
- Car repair – Last Christmas I backed up into a car while pulling out of my sister-in-law’s driveway. Since our insurance premium is $1,000 and the bill came to under $900, we paid for it in cash using our emergency fund.
- Insurance premium – Recently, we had a small oil fire in our kitchen. Thankfully, nothing except the oil burner caught fire and the fire extinguisher came in very handy! I didn’t have to dip into our fund at all, but had we experienced a loss of any kind, our renter’s insurance premium would have been $1,000.
Maybe my fund should instead be labeled “unexpected expenses.” Either way, the most I need saved in this fund would be around $3,500.
One reason I don’t count a job loss as an emergency is that I don’t have a steadfast 9-to-5 job that generates one stream of income. I’ve diversified my sources of income and count on any two or three in a given month. If I were dependent on one source of income, then perhaps saving 3-6 months of expenses would be a good rule of thumb to follow. But even then, most people can rely on unemployment benefits to cover some of their expenses. And, I think many people see the demise of their job before it actually happens giving them a little head start on searching for a new job.
So why do many proponents of emergency funds chant 6-12 months of expenses as a nice round figure? Most likely because they assume obtaining a job with a comparable salary will take that long, especially given the economy right now. But how long will saving 6 months of expenses take? Let’s say your income is $5,000 monthly. Your expenses are $4,500. You save $500 every month with the goal of saving $27,000 for a nice 6-month cushion. With interest rates hovering around 1.7%, it would take a little over 4 years to save that 6-month emergency fund.
I know I’m going against the grain on this topic, but I propose saving 3-months of expenses for that ever debated emergency fund amount. I’m making the assumption that most people foresee a job loss approaching and can start planning ahead before they actually get the ax. My second assumption is that most people qualify for unemployment benefits that can pad their emergency fund while looking for a new job. So given my two assumptions, using the same figures, a person would only have to save $13,500 in their emergency fund taking a little over 2 years to meet that goal. This seems much more palatable.
I know many people won’t agree and think saving 6 to 12-months is a much safer alternative. But I don’t like steadfast figures; things change, people take different paths and don’t always follow the formula laid out by many middle-class Americans in the buy a house by X age, make X amount a year, have a baby by X age, and retire when you are 55 or 65.
Maybe I’ve always been going against the grain and am just now realizing it.
What are your thoughts? Does the amount of the emergency fund depend of the individual’s circumstances? Or should the ER fund amount be a steadfast rule of thumb?