Emergency funds are a shield for your finances. When an emergency arises, your emergency fund allows you to take care of it without having impacting more fragile parts of your financial life. But it begs the quetsion, how much do you need in your emergency fund?
Emergency funds should hold 3-6 months of expenses. This allows you to support yourself in the case of sudden job loss, or handle a big emergency expense. To determine how much you need, calculate your monthly expenses, then multiply by the number of months that feels comfortable for you.
The dollar amount for an emergency fund will depend on both your lifestyle and your tolerance for risk. Read on to determine an amount that feels right for you.
What is an Emergency Fund?
Emergency funds are an account that you set aside in case of an emergency. An emergency can be a job loss, unexpected car or home repairs, or an unexpected medical bill. Emergency funds should not be spent on things like vacations, clothing, or other lifestyle purchases that are not an emergency.
Emergency funds serve to protect your finances when theses emergencies arise. Imagine you lost your job, and did not have an emergency fund set aside. You may have to dip into your investments, take on debt, or flash sell an asset (e.g. your home) to ensure you have money to survive. All of these actions can have long term consequences, and establishing an emergency fund prevents all that.
How Big Should Your Emergency Fund be?
An emergency fund should hold 3-6 months of expenses. Determining whether you should hold fewer months (3-4) vs. more months (5-6) worth of expenses will depend on your situation and risk tolerance.
You should consider any dependants (children or elderly parents), assets you own that may require an emergency repair (a home or a car), and what would happen if you ran out of money (is there people who can support you?).
You should also consider your risk factors. How secure is your job? Do you work in a volatile company/sector? How old is your car/home? Is there a good chance it will need a large repair? Do you have good medical insurance? Or is there a chance that a medical emergency results in a large bill? If you’re at high risk, a larger emergency fund would be wise.
For example, if you have no dependants, have no assets that could require an emergency repair, and if you ran out of money you could move back in with your parents, you may be fine to hold a smaller emergency fund. The chances of an emergency expense are low, and the worst-case (running out of money) would not be too bad.
Whereas if you had children, owned a home and two cars, and had no family closeby, you may hold a larger emergency fund. There is a greater chance of an emergency expense, and the consequence of running out of money would affect more than just yourself.
These are the type of things you consider when deciding how many months of expenses should be in your emergency fund.
How to Determine Your Monthly Expenses
To determine your monthly expenses, it’s necessary to track your spending.
The first step is to get a baseline of how much you’re spending in a month (this is also helpful in setting up a budget if you haven’t already). Go through your bank accounts, credit card(s), and receipts to determine how much on average you’re spending on a monthly basis.
From there, classify the spending in to living expenses vs. non-living expenses. Living expenses represent things that are recurring, and you can’t live without. For example, rent, groceries, or insurance. Non-living expenses may be things like buying clothes, going out for dinners, or events you attend.
Once you’ve determined your living expenses, it’s worth going through to determine what can be removed in the case of an emergency. If you lost your job, which pieces would you be able to sacrifice? For example, if you lost your job, you may cancel your fancy gym membership in exchange for a cheap local gym. This helps get a realistic picture of the base necessities.
What remains at this point is your base monthly expenses. It’s worth going back 3-6 months to ensure you aren’t missing anything, and to account for any fluctuations. Multiply this by your chosen number of months to determine how much you should hold in your emergency fund.
Is $5,000 a good emergency fund?
A $5,000 emergency fund assumes your monthly living expenses are between $833 (for 6 months) and $1,667 (for 3 months). Based on your lifestyle and risk tolerance, ask yourself if $833 for 6 months or $1,667 for 3 months is enough to weather any crisis you foresee.
A $5,000 emergency fund is likely sufficient if you do not have any dependants, do not own a vehicle or home, and have a safety net (e.g. family) in case you run out of money.
Is $10,000 in your emergency fund enough?
A $10,000 emergency fund assumes your monthly living expenses are between $1,667 (for 6 months) and $3,333 (for 3 months). Based on your lifestyle and risk tolerance, ask yourself if $1,667 for 6 months or $3,333 for 3 months will cover your living based on your situation.
A $10,000 emergency fund is likely sufficient if you do not have any dependants, own a vehicle but not a home, and have a safety net that can catch you if you run out of money.
Is $20,000 a good emergency fund?
A $20,000 emergency fund assumes your monthly living expenses are between $3,333 (for 6 months) and $6,667 (for 3 months). Based on your lifestyle and risk tolerance, ask yourself if $3,333 for 6 months or $6,667 for 3 months is enough to weather any crisis you foresee.
A $20,000 emergency fund provides a good cushion for most. This should be adequate if you have dependants, and own a home and car. You should still consider what happens if you run out of money, as if there’s no one to support you, holding more may make sense.
Is $100,000 in an emergency fund too much?
A $100,000 emergency fund assumes your monthly living expenses are between $16,667 (for 6 months) and $33,333 (for 3 months). Based on your lifestyle and risk tolerance, ask yourself if $16,667 for 6 months or $33,333 for 3 months is enough to weather any crisis you foresee. This monthly value provides a very extravagant lifestyle for most, and may be more than you need.
A $100,000 emergency fund is likely overkill, as you are sacirificing potential returns by holding it in an emergency fund. That said, if you have expensive assets, or your live has high cost to maintain, a $100,000 emergency fund may be appropriate for you.