Is there a good rule of thumb for how much I should have set aside as emergency cash?

Question

I'm buying my very first home, and should be receiving the $8,000 first-time home buyers tax credit. A majority of my savings are going to the down-payment of the house, but we still have a pretty solid reserve.

How much money should I hold in an accessible form in case of emergencies? I'd love to just throw down my entire credit to pay off my car, but I'm a little uneasy leaving my savings dwindling. Is there a recommended percentage-of-salary or percentage-of-standard-expenses to keep on hand?

Answer 1

If you are still paying off debt, then you should have about $1000 in savings and put all you can towards non-mortgage debt. If you don't have any debt besides your mortgage, then add up all of your monthly expenses including food, gas, utilities and keep 3-6 months in liquid savings. Whether you keep 3 or 6 months depends on how safe your income is. If you have a steady safe job, you might be safe with 3 months. But, if your employer is cutting back or you are in a commission based job or self employed - then lean more towards 6 months expenses. Congrats on your new home!

Answer 2

We aim to keep 6 months of expenses. The rationale is that its enough time to recover from most serious illnesses (that you can recover from) or a redundancy or pay for a large unexpected problem not covered by the insurance (e.g. the boiler dying).
It also gives us enough time to reorganise finances if needed. For example we could get out of contracts (like mobile phones, sky TV), sell the car, and maybe even find a cheaper house if needed in that time.

It will take a good chunk of time to build up that amount and it's worth considering how many commitments you have (kids, wife, mortgage, car...) as the fewer you have the less you need.
If you have fewer commitments you can be comfortable with much less contingency. When I lived in rented accomodation and didn't run a car or have many possessions, I just maintained enough cash to cover my bills for about 6 weeks, this would give me enough time to find another job, and if I didn't get one I could always crash round a friend's house.

Answer 3

While I certainly agree with the principle of paying down debt, there is some value in having a healthy cash cushion. If an emergency expense were to come up, and your credit has been cut-off or reduced to the point where you have no excess credit, then having real cash on hand is critical.

I would perform the following thought-experiment: What if my available credit had been cut off? How much would I need in cash to survive for 1 month, 3 months, 5 months, etc.? Consider what time period you'd be comfortable with, and set that amount as your minimum desired cash on hand.

While it may seem extreme to not have access to credit at all, during the credit crisis many banks and lenders "tightened" their lending: reducing credit limits, closing lines of credit, calling loans, raising rates, etc.

Suze Orman recommends cash savings equivalent to 8 months living expenses. That doesn't mean 8 months salary, but 8 months of what it would take to live on. At one point, in the midst of the economic crisis, I thought that made sense.

The Simple Dollar blog considers Suze's recommendation and the idea of emergency fund vs. debt repayment. Worth reading: Is Suze Right? Do Emergency Funds Now Trump Debt Repayment?.

Answer 4

Since it's not tagged united-states, I'd like to offer a more general advice. Your emergency fund should match the financial risks that are relevant to you.

The two main classes of financial risk are of course a sudden increase in costs or a decrease in income. You'd have to address both independently.

First, loss of income. For most, this would simply equate to the loss of a job. How much benefits would you expect to get, and for how long? This is often the most important question; the 6 months advise in the US is based on a lack of benefits.

With two incomes, you're less likely to lose both jobs at the same time. That's a general advise, though. If you both work for the same employer, the risk of losing two jobs at the same time is certainly real. Also, in countries with little protection against dismissal (such as the US), the chance of being layed off at the same time is also higher.

On the debit side, there are also two main risks. The first is the loss or failure of an essential possession, i.e. one which requires immediate replacement. This could include a car, or a washing machine. You already paid for one before, so you should have a good idea how much it costs.

The second expenditure risk is health-related costs. Those can suddenly crop up, but often you have some kind of insurance. If not, you'd need to account for some costs, but it's hard to come up with an objective number here.

The two categories are dependent, of course. Health-related costs may very well coincide with a loss of income, especially if you're self-employed.

Now, once you've figured out what the risks are, it's time to figure out how to insure against them. Insurance might be a better choice than an emergency fund, especially for the health costs. You might even discover that you don't need an emergency fund at all. In large parts of Europe, you could establish a credit margin that's not easily revoked (i.e. overdraft agreements), and unemployment benefits are sufficient to cover your regular cost of living. The main risk would then be a sudden lack of liquidity if your employer goes bankrupt and fails to pay the monthly wages, which means your credit should be guaranteed sufficient to borrow one month of expenses. (This of course assumes quite good credit; "pay off my car" doesn't suggest that.)

Answer 5

I think this varies considerably depending on your situation. I've heard people say 6 month's living expenses, and I know Suze Orman recommended bumping that to 8 months in our current economy.

My husband and I have no children, lots of student loan debts, but we pay off our credit cards in full each month and are working to save up for a house. We've talked through a few different what-if scenarios. If one of us were to lose our job, we have savings to cover the difference between our reduced income and paying the bills for 6 or 8 months while the other person regained employment. If both of us were to lose our jobs simultaneously, our savings wouldn't hold us over for more than 3 or 4 months, but if that were to happen, we would likely take advantage of the opportunity to relocate closer to our families, and possibly even move in to my parent's house for a short time. With no children and no mortgage, our commitments are few, so I don't feel the need to have a very large emergency cash fund, especially with student loans to pay off.

Think through a few scenarios for your life and see what you would need. Take into consideration expenses to break a rental lease, cell phone contract, or other commitments. Then, start saving toward your goal.

Also see answers to a similar question here.

Answer 6

How to start is pretty simple. With your next pay check set aside an amount and open a separate savings account. Since this is an emergency fund - you want it someplace where you can get to the money quickly (so a CD or mutual fund is not good), but you want it in a separate account so that you don't accidentally use it.

Once the account is opened I'd recommend setting up an automatic transfer, or make it part of the direct deposit if you do that, so that you put in some money regularly (every pay check). By adding to it regularly and not using it, you'll more quickly achieve your goal.

I'd recommend stopping, or slowing any retirement savings or other investing, until you get the emergency fund in place. If you have an emergency, the money in the retirement fund isn't going to do you much good as it costs too much to do an early withdrawal. The whole point of the emergency fund is to have liquidity when you need it so that you don't incur the costs of unplugging your longer term investments.

Also don't worry overly much about making money on this money. This isn't an investment it is there for emergencies.

Answer 7

I think that Dave Ramsey has a good approach to emergency funds. Save $1,000 that is immediately accessible in an emergency, pay off your debts, then build a 3-6 month fund.

Two years is great, but takes a really long time to build up.

Answer 8

6 to 9 months worth of expenses is recommended. You should also consider having long-term disability insurance in place, in case of serious illness or accident.

Answer 9

Between 6 months and a year is normally regarded as the "standard". Plan out what your monthly expenses are and save that money away. One thing to consider is what extras can you give up. If you are currently eating steak and lobster every day can you live with switching to ramen noodles for a period of time? Can you switch from premium cable to basic cable (or cancel it altogether)? Questions like this can greatly impact the amount you have to set aside.

I personally have my emergency fund in CDs that mature the first of every month. I know there is less liquidity in this approach but I'm ok with that. My emergency fund is a sum of cash I'll always have so I wanted to reap the benefits of a higher yield. If it comes down to it I can place an expense on a credit card and pay off the credit card when funds become available.

Answer 10

The bare minimum should be 6-months of expenses. Ideally, it should be at least 1 year. My personal preference is 2+ years, but one thing at a time.

Figure out your necessary expenses: food, shelter, transportation and necessary extras. An example of a necessity, beyond the basics, for me is a decent internet connection. Telephone costs is another good example. (Meanwhile, electricity and such bills should be included in the figure for shelter.) You may want to include some allowance for clothing as well; especially for the 2+ year plan.

Answer 11

The main factor should be what sorts of emergencies you are trying and also need to protect yourself against.

• Job loss? Figure out how long it'll take you to find another good job, not just the first one that comes along. If you're in a country you can get unemployment benefits, you might want to factor that in. Make sure that you can cover your current expenses for the time necessary, probably with a few months extra just in case.
• Emergency home repairs? Really depends on the expected repairs on the house (not planned ones, but ones you'll have to reasonably expect during the period you own the house.
• Emergency car repairs? I'd budget a few thousand for that...
• New, larger flatscreen TV? Just kidding...

Overall I'd say at least 6-9 months of expenses, adjusted for the above factors. More might be better but I'd probably keep that in a different type of investment vehicle, mainly because it doesn't really need to be accessible instantaneously like your normal emergency fund would need to be.

Answer 12

First you should maintain a monthly expense and find out the burn rate.
There would be certain expenses that are annual but mandatory [School fees, Insurance Premium, Property Taxes, etc].
So the ideal emergency fund depending on your industry should be 3 month to 6 months plus your mandatory yearly payments, more so if they come together. For example Most of my annual payments come out in May and I bank on the Bonus payout in April to cater to this spike in expense. So if I were to lose a job in March, my emergency funds would be sufficient for routine expenses, if i don't provision for additional funds
Second you need to also figure out the reduced rate of monthly burn and ideally the emergency funds should be for 3 months of normal burn and 6 months of reduced burn.

Answer 13

Many, many good answers here, but I like this one: One month's worth of expenses for each full percentage of unemployment. Therefore, it would normally float between, say five months and ten months. When the economy's hoppin' -- you have less to worry about. When times are tough -- beef up that fund.