One of the most basic and important fundamentals of every solid financial plan is to have an emergency fund. Your emergency fund is protection against life’s unexpected events, whether it be a job loss, illness, major home repair, or any other event that strains cash resources. Your emergency fund should consist of completely liquid assets, cash, or cash equivalents. You’ll want to keep these funds in a place where you have immediate access to it.
For this reason, many people choose to keep their emergency fund in a regular bank account or money market account. By having an emergency fund in place, you will be financially protecting yourself from life’s unexpected turns.
An adequate emergency fund has a lot to do with your personal circumstances, and professionals suggest having enough in your fund for three months to a year of expenses depending on your situation.
Many financial planners can agree on the following:
An emergency fund should be able to cover three months of “fixed and variable” expenses if:
- A person is single and has an additional and reliable source of income other than earned compensation.
- A person is married and both spouses have substantive and reliable earned income.
- A person is married and one spouse has an additional and reliable source of income other than the earned compensation of one spouse.
An emergency fund should be able to cover six months of “fixed and variable” expenses if:
- A person is single and does not have an additional and reliable source of income other than earned compensation.
- A person is married and they do not have an additional and reliable source of income other than the earned compensation of one spouse.
Once you have determined how many months of money you need to save, it’s time to figure out the actual dollar amount. You will want to tally up your yearly expenses.
The first step in determining the actual amount you’ll need in your emergency fund is to figure out your yearly expenses. Remember, these are expenses that must be paid.
This number will not include discretionary expenses such as gym memberships or dining out. The following are categories some examples of non-discretionary yearly expenses:
Residential: Your emergency fund should include savings for housing expenses such as rent or mortgage, property tax, insurance and utilities. Be sure to save for unexpected costs such as pipes bursting, trees falling or roof damage. You can call contractors, such as All Professional Remodeling, to get a quote. Simply add these costs into your budget to prepare for emergency situations
Personal Living Expenses: This can include anything from household supplies to food.
FICA and Income Taxes: Your taxes will not go away whether you have an emergency situation or not.
Health Care: Be sure to factor in the monthly cost for medical and dental insurance. If you are laid event, be sure to find out if you are eligible to stay on your former employer’s health plan for a specified length of time.
Debt Repayment: Your monthly payments for credit cards and other debt should be factored in to how much you save for an emergency fund in order to protect your credit score.
While determining your yearly expenses is somewhat subjective, you will want to arrive at a number that is as accurate as possible.
Once you have added your yearly expenses together, you will want do divide this number by twelve, which will give you the amount of money required to meet your monthly expenses. For example, if your total annual required payments are $98,000, divide this number by 12 for your monthly payments:
Now that you have determined that you need $8,200 per month, go back to the original guidelines to see if you fall into the three month emergency fund category or the six month emergency fund category.
If your emergency fund needs three months of cash, you’ll want to have $24,600 in your fund. If your emergency fund needs six months of cash, you’ll need $49,200.
Remember, your emergency fund is for emergencies only! A new pair of shoes is not an emergency. Nor is upgrading your vehicle or taking a cruise. This fund serves as your insurance to keep your head above water in case you are faced with an event that has a major impact on you and your family.