How Big Should Your Emergency Fund Be?

There’s an ongoing debate as to how large an emergency fund should be. The amount needed will be different for each person, for each household, but I’d like to look at the question from a different angle.

Emergency-Savings

How Much Should You Save for Emergencies?

Rather than making a recommendation based on a flat amount, like $1,000, or so many months’ living expenses, I think it’s more practical to look at what it is an emergency fund should be expected to cover before determining how large it should be.

What is an “Emergency” as it Relates to an Emergency Fund?

There’s no way to estimate how much money should be in an emergency fund without first defining exactly what constitutes an emergency worthy of tapping the fund. But let’s begin by focusing in on what it isn’t.

The World English Dictionary defines an emergency as “an unforeseen or sudden occurrence, especially of a danger demanding immediate remedy or action.”

Note the use of the words “unforeseen or sudden”; an emergency isn’t a routine or fully expected situation, like a shortfall in a monthly budget, routine car maintenance, or even replacing the roof on your house. All of those are fully predictable and require proper budgeting, but none are an emergency and shouldn’t be covered out of an emergency fund. If the fund isn’t held as a separate account with a clearly defined special purpose, it can easily degenerate into just another checking or savings account.

With that in mind, what emergencies should we be preparing our emergency fund to cover? Here’s the short list (and it should be short!):

  • Job loss or income disruption
  • Medical emergencies
  • Auto accidents or theft of vehicle
  • Damage to your home
  • An untimely, heavyweight car repair, like a valve job or replacing the transmission. Normally this would be something that should be budgeted for elsewhere, but since major car repairs have an uncanny knack for hitting at the same time as other emergencies — especially a job loss when you can’t afford to replace the car — it can easily rise to the level of an emergency.

Each of these are true emergency events that won’t fit neatly under an arbitrary allocation like three months living expenses, but would put you under a load of debt if you are unprepared.

Stocking Your Emergency Fund for True Emergencies

Now that we’ve defined what an emergency is and what it isn’t, let’s take a look at how to prepare for them with a fund. We’ll use an estimate for each category, then total them at the end to get an idea as to how large the fund should be.

Job loss or income disruption. This is where we can apply the “so many months living expenses” rule. How many months that will be will depend on personal circumstances such as how quickly a job in your field can be replaced, what other sources of income the household has, or even the size of investment assets that can be tapped in an extended emergency. At a minimum, this portion should represent at least one month’s living expenses to allow time for unemployment benefits to take effect. For our purposes, we’ll assume this to be $3,000 per month, and we’ll go for two months, or $6,000 as a bare minimum. (Your personal situation may dictate needing 12 months of expenses saved up. Each situation is unique.)

Medical emergencies. You should have an amount in your emergency fund sufficient to cover the deductible portion of your health insurance. We’ll assume a $2,000 individual deductible, and include it in the emergency fund.

Auto accidents or theft of vehicle. Just as with health insurance, you should have an amount in your emergency fund to cover the deductible on your auto insurance policy. We’ll use $1,000.

Serious damage to your home. Again, the deductible on your homeowners insurance policy should be added to the fund. We’ll use $1,000.

Heavyweight car repairs. Get prices on what it will cost to perform the most expensive repairs, like a transmission replacement. If it won’t be needed in a time of emergency, you’ll have the money available for other purposes. If it is needed, you’ll be ready. Let’s assume $2,500.

Now let’s total it all up:

  • Job loss, two months living expenses: $6,000
  • Medical emergencies: $2,000
  • Auto accidents or theft of vehicle: $1,000
  • Damage to your home: $1,000
  • Untimely, heavyweight car repair: $2,500

Total for emergency fund: $12,500

As you can see, the emergency fund calculation we’ve used here doesn’t fit neatly under any rules of thumb — we’re matching funds with probable emergencies.

Avoiding Duplication

This is of course a more detailed method of calculating the size of your emergency fund, and part of the reason is so that the fund isn’t any larger than it needs to be. Once true emergencies have been identified and prepared for, any additional money should be in investments that provide greater returns or utilized to pay down debt.

It isn’t necessary, desirable — or even possible — to cover every emergency outcome. For example, health insurance policies typically include an annual individual deductible and a family deductible — usually equal to two or more individual deductibles. You may want to cover multiple deductibles, but what are the chances that two or more members of the same household will experience high medical costs at roughly the same time?

The same is true of auto insurance deductibles — if you have two or more cars, there’s probably no need to prepare for accidents or theft of more than one car, especially if all drivers in the household have good driving records.

Even if either event did happen, your fund has allocations for multiple emergencies, some of which won’t happen in conjunction with others, so funds will be available just in case. In addition, greater concentration of funds in income producing investments can provide a second level of funding in a worst case scenario. In the end, while there are multiple reasons to have an emergency fund, the main purpose is to give you time to deal with what ever comes your way.

How do you determine how much you should have in your emergency fund?

Photo via Wikimedia Commons.

About the Author

By , on May 16, 2013
Kevin
Kevin Mercadante is a professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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{13 Comments}

  1. Matt says:

    It’s no fun to think about, but emergencies are important to plan for. I almost feel that families need two funds, one for emergency repairs/replacements and one for job loss.

  2. I recommend to keep it simple. Two income family earners; 3 months of net income. Single family earner; 6 months of net income. Don’t get caught up in what is an expense.

    • Kevin says:

      Hi Robert – That works as a very basic guide, but I think it also needs to be tweaked based on personal circumstances. As mentioned above, stabiity of your income is a factor, but so is the age of your car(s) and even the ages of your children (younger means potentially more emergencies). That’s why I stray from the number-of-months rule – it can leaves some with insufficient emergency funds, and others with over-funded ones.

      • Good point Kevin, however, if your individual circumstance calls for more specifics that are known such as your car or children, then are those items are not truly emergencies and should have a specific savings component in your budget (ex. Line item for car repairs or tuition, etc). Currently, I have a car that has 180,0000 miles on it. Therefore, I have been beefing up my auto repair budget item and maintaining a sinking/savings fund to eventually replace my car.

  3. I’m one of those people who strongly stands by having a large emergency fund. 15k is my magic number, but I’m also a freelancer whose income varies and really slows down over the summer, so I like having that extra cushion!

    • Kevin says:

      Given your occupation, that’s the right approach. The size of your emergency fund should be in inverse proportion to the stability of your income.

  4. Terry says:

    Those are useful tips.

    In the case of big appliances (refregerators and washing machines), I find it’s a good ideas to start anticipating that you will need to replace them after 15-20 years.

    • Kevin says:

      Agreed Terry, those aren’t emergencies, they’re assets that have an expected shelf life that we can budget for. That’s also true for most car repairs, except it’s harder to budget because of the number of possibilities and the wide range of costs involved.

      Even if you budget for the eventual replacement of your car, you will still have car emergencies along the way. The smaller ones might be easily covered in your regular budget. But the big ones…that’s why they’re emergencies!

  5. Great considerations above. Depends on family size, type of work, and expected expenses for six months.

    • Kevin says:

      Absolutely, Mike. There really is no one-size-fits-all strategy when it comes to an emergency fund. You may also have financial considerations not commonly thought of, such as child support payments that are legal obligations that don’t go away because you lost your job.

      • I believe your observation that there really is no one-size fits all strategy is right on target. Everyone’s job situation, marital status, age of vehicle(s), age of appliances, etc. will vary. While starting off with some generic number (e.g. $10,000, 3x living expenses, 3x monthly income) might be a good basis for a start, a detailed analysis should be conducted. I also advise people not to go overboard with an emergency fund, as all money sitting in a low yield account (presumably where an emergency fund is held for immediate access) isn’t taking advantage of compound interest.

  6. Andrew Ghezzi says:

    Cornerstone advice for what many consider to be the start of any decent Financial Plan.

    Kudos for adding in the car repair concept. For many people who plan for normal “home improvement” emergencies ( boiler breaks, tree falls, dishwasher dies…etc..etc) often times I see that the car side of the equation is left out.

    Big difference these days when repairing say a Honda vs. an older used car that needs to retire!

    Great article.

    • Kevin says:

      Thanks Andrew. I actually think that major car repairs are more significant in an emergency fund. Not only are they generally more likely to happen than major home repairs, but your ability to earn a living will be impaired if you don’t get the car fixed. That’s a real emergency.

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