Emergency funds are tricky things. While my husband and I steer towards the 6-8 month emergency fund mark, others are comfortable with the 3-6 month timeline that is most commonly recommended. Still others prefer to have a full year’s supply of cash on hand. Let’s walk through how to determine how much should be in your emergency fund.
How Much Time Should I Plan For?
The answer to this question is fairly simple - based on your career (or your career prospects), how many months would it take you to find a good, stable, career-building position from your current employment or schooling? Different careers have different paths, and sometimes a rebranding is necessary. Plan on at least two weeks to recover from the shock of being unemployed, and then add however many weeks/months you think it would take you to find that new employment.
Now multiply that number by 1.5, because you want a buffer. Just look at the 2008 Recession, or, more recently, the economic chaos caused by COVID-19. If you lost your job, it may not be all bread and roses as you search for a new one. If your number is under 3 months, I would highly suggest you round up to that figure.
Which Expenses Should I Plan For?
There are a few ways to calculate how much money you need to cover the amount of time you have, but all of them presume you have a budget. If you don’t have a budget, then categorize last month’s expenses as detailed in the First Budgeting Session - you need that data to do the rest of this exercise. (If you are truly unhappy with the idea of taking that much time right this minute, assume that your monthly net paycheck is how much you spend per month. But you should really do the budgeting exercise, because you need a budget anyway).
There are some expenses that are necessary to sustain life. These expenses include food. There are also expenses that preserve safety of life, like rent and paying for clean water access. I label these the essential partitions of your budget. Basic groceries, rent/mortgage payments, a small fund to replace needed shoes and coats (or larger clothing for growing children), and electricity bills fall into this category. Little else does. I know it might sound harsh, but guess what? You do not need coffee to survive. You do not need chocolate to survive. You do not need makeup to survive. You do not need so many, many needs in order to survive. Maybe you need them to thrive, but we aren’t talking about thriving, we’re talking about surviving.
Some people choose to create their emergency fund based off this survival calculation. If you are fine with the idea of cancelling every subscription you have (including Internet service) the day you lose your job and spending every minute possible at the library applying for new jobs, then this is the approach for you (make sure to plan for bus pass money, because you will need to suspend your car insurance). For most people, this is not realistic, but there are a very few who know how to tighten their belts when the need comes.
There are some expenses, previously alluded to, that are necessary for thriving. These expenses may include your car insurance payments - if having a car legitimately improves the quality of your life and your social mobility, then having a car is worth it, and it is worth it to drive it legally. Other necessary for thriving expenses may include some subscriptions. For example, my husband genuinely thrives off Netflix. As a movie and audio junkie, he gets true enjoyment from viewing (and listening) to movies. After watching a movie, he will animatedly talk about the various ways the sound design enhanced the film, and it provides him with inspiration to use in his own work. For me, my thriving expenses include an occasional (1-3 times a year) very nice dinner out, and web domain payments to keep my websites up and running (as those websites provide me with almost endless hours of creative outlet).
There are also some expenses that are simply luxury. These include travel/vacation expenses (almost all of the time) and things like trips to the salon to get your hair and nails done. Quite frankly, there should be few-to-none of these in your budget anyway. However, if you can afford it and you really want it, it is also not a criminal offense to engage in luxury spending (especially if it has its own partition in your budget).
Now that we understand these different types of expenses, it is time to decide what to do with them. You need the survival amount each month - those expenses are non-negotiable. Choose some (or all) of your thriving expenses that you would want to continue in the event of a job loss, and, if you feel you should, calculate in a luxury expense or two. Then think critically about expenses that would go down naturally if you had no income. For example, my husband and I observe the Biblical law of tithing - we donate 10% of our income to the church we attend. Since 10% of zero is zero, that monthly expense goes to zero in the case of unemployment. Other less obvious expenses may include reduced car expenses (less wear and tear from commuting, less spent on gas/oil changes, etc) and eating out (if you tend to purchase lunch out). Also consider costs that may go up - if your house is empty most of the day right now, calculate in an increase in your heating bill to accommodate the idea of having someone there all the time. After adjusting all those figures, add up that monthly spending, multiply it by the number of months you need as your emergency fund, and wallah - you have your magic number.
What thriving expenses do you calculate in your emergency fund? How many months do you like to save for?
I spend most of my spare time playing with spreadsheets, my violin, or planting vegetables in my garden in hopes of bringing new insights into frugal living. Please enjoy, and don't forget to sign up for our monthly newsletter here.
Disclaimer - Mrs. FB is not a financial advisor. Nothing in these articles should be construed as investment or other professional advice, but rather personal opinion. Some links in these posts may be to affiliate sites - no products are advertised through this site that have not been personally used by the FB family unless expressly labeled.