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Remember to Adjust Your Emergency Fund Limits

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Today must be emergency fund day because earlier this morning I talked about how you shouldn’t rely on credit as an emergency fund; now I’m going to remind you that you should adjust your emergency fund limits based on any changes in you or your environment.

Having an emergency fund is one of the cornerstones of a solid personal finance plan. Whether you subscribe to the three month, six month, or full year’s worth of expenses, an emergency fund is something that every single person and family needs. Emergency funds enable you to weather the difficult times, especially since they all seem to cluster together, without putting you in an even worse situation. Some people rely on credit cards to supplement the emergency fund and others will only rely on credit cards at the last moment, but ultimately you need to have an emergency fund that matches both your needs and the chance of a Bad Thing happening.

The first part of that last sentence is pretty well understood by people who have emergency funds. Most people are very aware of their own needs and how it affects their emergency fund. If you buy a house and have to service a mortgage, it’s clear that the emergency funds requires additional padding. If you have a child, most people recognize that the emergency funds need to be boosted to weather any additional crises that come with children. For those of you who understand risk analysis, the part people understand best is the impact or severity of a risk.

The part people are less cognizant of is the second part. In risk analysis, we’re talking about the probability (as opposed to the severity) of a risk occurring. Specifically, we’re talking about people changing their planning as the probability changes. For example, the onset of a recession increases the likelihood that you will be fired or laid off. While the severity of being fired remains the same (you lose the same amount of salary regardless of future he economic prognosis), the probability increases based on the economy and the industry you’re in.

So, how do you do this? Periodically sit down and re-assess your financial plans. Check out your retirement accounts, check out your bank statements, and check your emergency fund. Think about whether the environment has changed and whether you need to increase or decrease your emergency fund. Now, if you think a potential recession will increase the chances you’ll be fired, boost your emergency fund. You’re essentially self-insuring against being fired (and other negative events). As long as you recognize that the environment has changed and your emergency fund needs to as well, you’ll have done what you can to help weather any potential downturn. You can’t predict the future but you can at least prepare for it as best you can.

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5 Responses to “Remember to Adjust Your Emergency Fund Limits”

  1. Carol says:

    Beware nit-picking in this post.

    crisis’s -> crises. You’re looking for plural (one crisis, two crises), not possessive (the start of a crisis = a crisis’s start).

  2. Frugal Dad says:

    Our emergency fund has fluctuated some over the years, based largely on the factors you describe. When things tend to head south in the economy, or in my line of work specifically, I tend to sock away more. As things ease up I may use some of that fund to do some “outside-retirement-accounts” investing.

  3. jim says:

    Carol: Thanks, I had spelled it ‘crises’ at first but the Firefox Dictionary told me it was misspelled, thanks for the correction.

  4. A useful guideline for me has been reassessing my emergency fund limits when we have a major life change, such as a job change or the birth(s) of our children. I’m currently of the “everything in cash” school, so it’s been a simple matter of increasing the amount in the account designated as the emergency fund. However, I’m thinking of moving some or even most of the funds into a money market fund, which has a little more risk but certainly not a lot. I need to understand more of the tax implications, though, since I’d be moving to a tax-exempt MMF.

  5. adfecto says:

    That sounds like an engineer talking: mishap severity and probability of occurrence. That’s exactly how you analyze risk whether it is for a rocket or a job loss. Great post.

    It frustrates me how it is so often easier said than done when it comes to turning around your finances. Growing the account balance quickly enough to react to the changing environment is tough. Today it might be twice as likely that a person gets laid off than 2 months ago (thus I know I need more money), but doubling the emergency fund to react to the changing probability is not a trivial thing. Putting back $100 a month (my current emergency fund contribution) isn’t going to bring my mitigation into line with the risk for several years (by which time the risk has decreased).

    I look forward to the day that I have 2-3 times my salary in a taxable brokerage account and increased risk simply means moving a little more into a money market fund rather than stocks. Normally it would be equal to 6 months salary, but in turbulent times a click of the mouse could double or triple the safety net. In the meantime, Plan A is a couple thousand in a high yield savings and credit cards are still my Plan B.


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