How Much Should You Have Saved for a Rainy Day? Use Our Emergency Fund Calculator
We may not be able to predict the future, but we can try to budget for it.
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The events of 2020 provide perfect validation of the need for everyone to have an emergency fund. No one expected a worldwide pandemic that would send the stock market on a rollercoaster ride, shut down major industries, and lead to hundreds of thousands of hospitalizations and unprecedented unemployment. Having an emergency fund is a huge element of financial literacy.
Unfortunately, 2020 has been a rough year, to say the least. Regardless of how much you’ve been impacted by the pandemic and the toll on the economy, this situation serves as a good reminder that there are a multitude of things outside of our control that can impact us.
A big part of your financial health involves being prepared for the unexpected. We might not know what is going to happen, or when it will happen, but we do know that unexpected challenges will arise sooner or later. How well we’re prepared for those challenges will significantly impact our long-term financial health.
What Is an Emergency Fund?
An emergency fund is all about preparing for the unexpected. As the name suggests, this is money that you set aside to be used in case of an emergency. That emergency could be the loss of a job, health issues and medical bills, a natural disaster, family issues, or anything else that you can’t plan or budget for.
The idea behind having an emergency fund is that the money will be used only for a true emergency. It should not be touched for any other reason. Having an emergency fund won’t prevent the unexpected from happening, but it will prevent your financial plans from getting easily derailed.
Without an emergency fund, you’re much more likely to wind up in debt as the result of unexpected events. If you don’t have money set aside specifically for an emergency, you might need to turn to credit cards, payday loans, or a line of credit in order to get by.
What Qualifies as an Emergency?
One of the common mistakes that are made with emergency funds is using the money for the wrong purposes.A true emergency is something that is unexpected, important, and unplanned.This money should not be used for irregular expenses that you know are coming up.
For example, an insurance policy with an annual premium is a payment that you don’t need to make every month, but it’s not an emergency because you know when it’s coming and how much it will be. You should be setting money aside each month as part of your budget even if the premium is only billed annually.
Likewise, you should not use an emergency fund to cover the cost of an oil change for your car. Routine maintenance is something that you can plan and budget for.
If you use your emergency fund for things that are not true emergencies, you’ll wind up depleting your savings and the money won’t be there when a real emergency arises.
How Much Should You Have in Your Emergency Fund?
The amount that you should have in your emergency fund is a matter of opinion, but most experts recommend somewhere around six months’ worth of living expenses.
That means if you spend $3,000 per month in regular living expenses, it’s a good idea to have $18,000 saved for an emergency. That way you’d be able to cover all of your bills for six months even with no income at all, without incurring any new debt.
This is just a general suggestion and there are a number of factors that can impact how much you should have in your own emergency fund, including things like your:
- Family situation
- Employment type
- Other income
If you have a family, especially kids who are dependent on you, you’ll need a more significant emergency fund compared to a single person.
If you’re self-employed or if you have unpredictable income (like a sales job that is 100% commission-based), you’ll be at a greater risk for an unexpected drop in income.
If your family consists of multiple people living on a single source of income, you’re at a greater risk than a dual-income family.
These are factors that you’ll want to keep in mind as they may impact how much you need to have saved based on your own level of risk.
Emergency Fund Calculator
If you’re ready to see how much you need to have saved, use our handy emergency fund calculator below.
To get started, you’ll need to know how much you spend in each of the major budget categories every month:
- Personal Spending
These categories are based on Dave Ramsey’s recommendations, minus the categories of giving and saving (which you would probably skip during an emergency).
If you have a budget, you’re in good shape because you already know how much you spend. If you don’t have a budget or track your expenses, you can go back through credit card and bank statements to put your best estimate together. Don’t forget to also estimate the amount of cash that you spend in these categories each month.
Even Small Amounts Can Make a Difference
If you’re like most people, the calculation shows that you need a lot more than you already have saved for an emergency. Seeing that you should have $50,000 and you only have $500 can be pretty disheartening, but don’t beat yourself up over it. And definitely don’t allow a large number to feel impossible and discourage you from saving at all.
Although the goal is to save enough money to cover six months of living expenses, it’s important to realize that even small amounts can make a big difference. Having just $1,000 in an emergency fund may be enough to cover unexpected bills. Without that $1,000 set aside, you might have to put the expense on a credit card and pay 20% interest until you can get it paid off.
Don’t be afraid to start small. If you have nothing set aside as an emergency fund, focus on getting $500 or $1,000. Once you’ve achieved that goal, set a higher goal, and keep moving forward.
Is It Possible to Have Too Much in Your Emergency Fund?
If you’ve been saving for a while and you have a healthy emergency fund, you may want to look at doing other things with your money rather than continuing to build a bigger emergency fund.
Typically, your emergency fund will be kept in an account that does not earn a lot of interest (more on this in a minute). As a result, money that you keep in an emergency fund is likely to grow slower than your other investments.
Once your emergency fund is at a sufficient level, you’re better off investing other money in different ways. Your portfolio and net worth will grow faster, and you’ll still be protected in case of something unexpected.
Where Should You Keep Your Emergency Fund?
The most important aspect of your emergency fund is accessibility. It should be kept in an account that can be easily accessed on short notice if needed. You don’t want to have an emergency fund in an illiquid investment because when you need it, you may have to wait a while to actually get the cash.
Another factor that you’ll want to consider is investment risk. Most people prefer to keep their emergency fund in a safe account where it’s not at risk of losing value overnight.
For these reasons, savings accounts and money market accounts are common choices for emergency funds. You can access the money at any time (it might take a day or two to transfer money from an online bank to your checking account) and there is no investment risk.
However, your choice can be impacted by your personal preferences and your tolerance for risk. While the need for liquidity is always important, some people are comfortable keeping their emergency fund in higher-risk investments, with the goal of earning some returns since that money is likely to be sitting there unused.
Some types of investments like stocks, ETFs, and mutual funds can be liquidated at any time, so they meet the requirement of being accessible.
For most people, a simple savings account or money market account is a good choice. But if you’re more aggressive and you want to maximize growth, you might consider keeping your emergency fund in an investment that offers the chance for a better return.
How To Build Your Emergency Fund
By now, you should be convinced that having an emergency fund is important, but you might be wondering how you can actually make it happen. Here are a few tips.
- Start small. If you’re starting from scratch, don’t set the goal of saving enough to cover six months of living expenses. That will likely seem too big and overwhelming. Instead, start with a small goal like $1,000 that will get you on track, and then you can keep going from there.
- Build it into your budget. You’ll need to save money on a regular basis if you want to have a sufficient emergency fund and you can’t do that by only setting money aside here and there. Put it into your budget and make it a priority to save towards this purpose each month.
- Automate it. You can set up automated transfers from your checking account to a savings account to ensure that you’re consistently saving. Set up an automatic transfer that will come out of your checking account after each paycheck.
- Start a side hustle. There are a lot of ways you can make extra money on the side, and we’ve covered many of them like retail arbitrage and blogging. A side hustle is a great way to make extra money that can be saved for an emergency fund.
Not sure what side hustle is best for you? Take our quiz:
Do you have enough saved for a rainy day?
While it may not be the most exciting part of personal finance, an emergency fund is a necessity if you want to be protected from the financial damage that results from unexpected events. As we’ve seen throughout the past year, the unexpected can happen at any time, and it’s best to be prepared.
But not everyone agrees with this mindset—some people like to live on the financial edge. OR other people prefer to keep a minimal emergency fund in lieu of other financial opportunities.
What’s your stance on emergency savings? Do you have more or less than six months stashed away? Let us know in the comments!