How big should your emergency fund be?
An emergency fund is an amount of money that you put away for when a rainy day comes. Rainy days can come in an infinite variety – from the gearbox packing up on your car, to your roof leaking, or being made redundant – the list is endless. Its money that you can call on quickly to fix these events in life which you know will come but don’t know when they’re coming. Events which are just that bit bigger than your usual monthly budget can cope with.
I think that having an emergency fund is an essential part of developing a financial plan and the first thing I’ve done since deciding to turn my financial life around is save £1,000 (or $1,600) which is the absolute minimum amount that anyone should aim for.
I’ve saved this £1,000 to try to break my cycle of never having enough ready cash for a rainy day, and to help stop me loading these sort of events onto a credit card – which I know I will only ever pay off the minimum balance.
In an ideal world – most financial experts recommend that people save a minimum of four to six months living expenses to help them through lifes disasters – but I’ve always thought that this is a too simplistic rule of thumb.
At present, my emergency fund will remain at the £1,000 level as I’m currently paying of £22,000 ($35,000) of credit card debt. To me, there seems to be no reason to have significant amounts of cash sitting in the bank while I’ve got large debts. As my card balances lower, then my capacity to cope with emergencies will grow as the amount of available credit I have increases.
Not the best situation to be in, but I think it’s the most reasonable approach under the circumstances. Once my debts are cleared then the first thing I shall do is build a meaningful emergency fund.
When I finally get to my DFD (debt free day) I think that having a minimum of four months living expenses plus 5% of the value of my house should be my goal. My living expenses are £1,000/month ($1,600) and 5% of the value of my house is £6,500 – so an emergency fund of £10,000 ($16,000) should do me quite nicely.
However – It would make a piece of my heart shrivel and die knowing that I had this amount sitting in a bank doing nothing. So in all honesty I would probably have 50% of it on instant access deposit, and the remainder in some sort of short dated corporate bond fund – where I would at least hope to get a return that beats inflation.
I’ve described above what I’ve done so far and what I intend to do in the future, but how big your emergency fund should be is a purely personal matter. What works for one person, doesn’t necessarily work for another.
Peoples living expenses vary, things like whether you are a home owner or not come into the equation.
Home owners need a larger emergency fund as they might have expensive boiler, furnace or household repairs to undertake which renters just get their landlord to do.
Also – things like the number of children you have, the earning capacity of your partner, and your attitude to risk all have a bearing on how much of an emergency fund you are comfortable.
If you sit down and think about how many different things might spring up and make a claim on your time or cash it can be quite a sobering experience.
Having the cash at hand to deal with lifes unwanted but half expected events should take the pressure off slightly and help you sleep better at night.
Not having the cash might financially break you – beware.
How big should your emergency fund be – what do you think ?