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Adjusting Your Emergency Fund

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3 months. 6 months. 12 months. How many months of worth of expenses do you have saved up in your emergency fund? How many should you have?

I think it’s difficult to peg down a specific number until you take full stock of your situation so any expert who claims that any time period is for you, besides that you probably want a minimum of 3 months, is just giving you an answer to be rid of you or hasn’t thought it through yet.

First, let us consider the major reasons why you would need to dip into your emergency fund:

  • Medical emergency.
  • Loss of job.
  • Forgotten maintenance or unforeseen repair expenses.

Again, those are major reasons, there are plenty of other smaller reasons for the emergency fund but those three are the biggest and most frequent events so I’m going to focus on those. In all instances, the emergency fund is meant as a temporary funding source that should cover those events so that you can pay for those things without having to take out a loan.

Now, let’s say we start with the general advice of 6 months. How likely are you to have a medical emergency, loss of a job, or maintenance/repair expense? You’ll have to decide that on your own! If you have a family history of a medical condition and your age suggests you might be susceptible, you might want to add a few months. If you’ve noticed a recent downturn in the job market in your area, you might want to add a couple months breathing room in case you are let go. If you have an older car or an older home, you might want to add a month or two just in case you need to replace something like a water heater. Consider your particular situation and adjust as necessary.

What about some mitigating factors?

  • Spouse has a job.
  • Renting out a room in your home.
  • Insurance.
  • Other income.

The bulk of the mitigating factors are sources of income not directly tied to your full time job. The reason they are mitigating factors is because if you do lose your job, they represent another source of income that can help cover your daily living costs. The danger is in putting too much of an emphasis on these mitigating factors, especially in the case where they’ve been fully integrated into your budget.

An example of this would be in renting out a room in your home, if the rent is 100% going towards the mortgage and you’re depending on it to make payments, then it’s not really a mitigating factor. In fact, I would call it an extenuating factor because if the renter leaves, you’re stuck paying more for the mortgage.

So, examine your own situation before blindly listening to advice of a 3, 6, 9 month emergency fund because it may be too much or too little for your situation. We currently have a three month emergency fund sitting in a high yield bank account, earning 5%, which is perfect for our needs. How about yourself? Any good (common) mitigating factors?

{ 11 comments, please add your thoughts now! }

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11 Responses to “Adjusting Your Emergency Fund”

  1. plonkee says:

    In thinking about this for myself, when you say medical emergency, what do you envisage that the money would be needed for?

    I’ve never had one myself (touch wood, of course) so are you referring to medical bills (which I wouldn’t get, really), or are there lots of other costs that I haven’t thought of?

    • SarahJane says:

      Health and Disability coverage may help with some things, but won’t cover everything affected by a serious medical emergency. For instance, you may not be able to care for your children/pets/yard etc. and need to hire a caretaker, you or a family member may need to take off work to care for the ill/injured person, your nutritional needs might change, you may need to purchase medical equipment or supplies, etc.

  2. alex says:

    I agree that its a completely personalized calculation. I support trying to create an emergency fund from as many sources as possible. I hope to have about a month’s worth of expenses in cash, and then have another 3 or 4 months worth of expenses in a HELOC. Hopefully this system will minimize the opportunity cost of having such a large amount of money in cash.

  3. It’s all about managing risk. For example, an emergency fund can also be used to cover insurance deductibles. Insurance companies do this for a living. For a specific, and somewhat extreme example, I recently raised my flood insurance deductible to the legal maximum in my state, which is $5,000. The deductible was previously at $500. The statistical odds of a flood causing significant damage to my home is approximately one in 100. My premium is now $600 lower per year. Invested safely, it would take $12,000 to earn $600 per year, assuming a 5% return (before compounding). Since I am only “risking $5,000″ in deductible (or $4500 more than the previous $500 deductible) I’m “earning” closer to 30% for the amount of money I am risking. Not a bad “investment.”

    I’m sure Blueprint has commented on this subject before but raising deductibles to lower premiums, thereby increasing your cash flow, will almost always work in your favor. A simple understanding of risk and reward is worth your time.

    Insurance companies have large buildings for a reason…

  4. NCN says:

    I have a “basic” emergency fund of 6 months worth of “expenses”… think “living on the bare necessities”… to cover if I were to lose my job… then, on top of that, in the same account, I have money saved for irregular expenses that I may or may not have enough budgeted money to cover… for instance, if I get a bonus in December, I’ll use that money to pay for car tags… but, if not, I’ll use the surplus in my “emergency fund”… In fact, I’m thinking of getting away from the emergency fund concept and going w/ a “slush fund” concept…
    NCN

  5. Jason says:

    Let me by honest. I’ve never understood why everyone advocates an “emergency cash reserve.” Personally I wouldn’t want to have even three months of expenses in cash earning even a money market’s 4+% interest rate. I would rather put that money to work for me across several blue chip stocks. Sure the stock market goes down, but not for several consecutive months across all major blue chip stocks. Of course you have to be only as conservative as your present position allows. While my “emergency fund” is in some tech stocks and consumer goods, I’m more secure in my position (and medical coverage) than some people. The idea of putting even 3 months into a cash account just doesn’t seem to make financial sense to me.

  6. Margo says:

    I saved aggressively for awhile until I hit 3 months’ expenses. I’m young, single, and rent, so I could probably stretch 3 months’ true expenses into 6 months if I really hit dire straits. Now, I do what a friend does, and charge myself a monthly amount for “self-insurance”.

  7. Foobarista says:

    One factor that’s important is job stability. I’ve spent my career in startups, so I’ve always kept a fairly big emergency fund. But now that I have a fair amount of (post tax) income from investments, I’ve been moving money from my e-fund into the investments, to get down to a six-month reserve. It had been as high as a year in the early 2000s after the dotcom meltdown.

    If your career is high-risk, your medium-term investment strategy may need to be lower risk.

  8. Margo says:

    I’ve heard of doing 1 month’s expenses for every $10k in salary. The theory behind it is that it’s much easier to find a new $40k job than a new $120k job.

  9. Moneymonk says:

    My cousin only keeps 1 month of expenses as cash reserve, Why? b/c he has a broad range of other income sources. He is well balanced.

    I am in the computer field so I always keep a job. So I on purpose do not build a large (6 months) emergency fund. Regardless of what the experts say. 3 months is my max!

  10. Eric says:

    Maybe I’m ultra conservative, but I don’t like to leave a whole lot to chance. Isn’t is possible to lose your job, get sick, and have your car break down all at once?

    A savings reserve for car/house repairs and insurance deductibles should be calculated separately from an income reserve. It gives more clarity to what you’re preparing for and how much that should equal. It may end up equaling 6 months’ income, but I’d rather come to that number by saying, I want to be prepared for 3 months unemployment and also be able to pay for emergencies during that time.

    In response to Jason, sure the blue chips might not stay down for long, but the point is you might need that money when they ARE down. If anything, that is more likely, since you have a higher chance of losing your job when the economy as a whole is down. In that case you could be using up a higher percentage of your capital than if you’d kept it in savings. Personally, I’d rather keep my savings in savings, and not have to pull my investments at their weakest point.


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