In our last SquareOne blog, What’s The Deal With Emergency Funds? we discussed what an emergency fund is and what it is not, but you might be wondering how much cash you should have set aside. If you crack open a personal finance textbook, the most common answer you will see is “three to six months of expenses,” but how do you determine where you fall on that scale?
That depends on a myriad of factors that are all unique to you. What does your job security look like? Do you have high-interest debt? What exactly are your living expenses anyway? To figure this out, you need to look at what you are spending each month on average. Review your bank account over two or three months and find out what you typically spend on life necessities such as rent, utilities, health insurance premiums, transportation costs, minimum debt payments, and food.
Below are three example situations that could influence how big your emergency fund should be:
I have high-interest debt I would like to begin paying down.
In this case, the pressure of high-interest debt can be overwhelming. Start small by building an emergency fund equal to one month of living expenses before you begin paying off debt. This allows you to cover unexpected expenses, like car repairs, without having to use your credit cards again. Once you have one month of expenses in your emergency fund, continue the good work of growing your emergency savings while beginning to attack your high-interest debt balances. (We’ll talk more about paying down credit card debt later.)
I work a commission-only sales job that lacks long-term job security, or I am an independent contractor.
In this case, your goal should be on the higher end of the spectrum. Not only can the stream of income be less consistent compared to an individual who earns a monthly salary or a regular hourly wage, but your job position could also change dramatically if market conditions shift. For independent contractors, you also need to plan for self-employment taxes and income tax estimates, so include those items in your monthly expense number.
I feel confident about my job security, earn a consistent wage, and have no high-interest debt.
In this case, your emergency fund could be on the lower end of the spectrum and closer to three months of living expenses with the idea that more money is going to a savings account. However, if you feel more comfortable with a more significant buffer, that is okay too.
Whatever your situation, don’t be afraid to start building your emergency fund because the dollar amount seems unattainable. Set small goals along the way to remain motivated. Setting a goal of building up $500 in a savings account is better than not saving at all. Before you know it, you have accomplished that goal, and you will be ready to set your next target.
In our next SquareOne blog, we’ll talk about where you should keep your emergency fund (and it’s not necessarily your local bank’s savings account.)
SquareOne: A Financial Foundations Blog is a personal finance series from The Welch Group created to help provide readers with the foundational knowledge to be purposeful with money by identifying key financial concepts to help the reader control their financial future. Foundation topics include personal savings strategies, debt consolidation and reduction, life planning, retirement planning methods, and beginner essentials of investing and taxes.
