When it comes to building an emergency fund, one thing is clear: It's a necessity. In fact, the question isn't whether or not you should be setting aside funds for that proverbial rainy day, but rather how much you should be saving.
Ideally, you've set up a separate savings account for your emergency funds. Keeping these savings in a separate account will create a psychological road block of sorts, in order to discourage you from spending the funds on nice-to-haves, like a cruise or a new couch, rather than costs associated with a true emergency.
Maintaining an emergency fund account will also help you avoid having to liquidate other investments should the need arise.
But this still begs the question: How much do you need to have in your emergency fund? Read on to see what our wealth advisors have to say.
Financial Strategies: Avoid the Cookie Cutter Approach
First, know that there's no one-size-fits-all answer to the question of emergency savings. After all, everyone's financial situation is different, and that means that everyone's emergency fund needs are different, too.
Most wealth advisors suggest keeping three to six months of living expenses tucked away in an emergency fund. That way, if the unthinkable happens — you lose your job, your spouse has a medical issue, you experience a natural disaster — you'll have enough funds to cover several months of living expenses. According to the U.S. Department of Labor, the average consumer unit (household) spends $53,495 per year, or an average of $4,458 per month.
Keep in mind that, for an adult without dependents, three months of expenses represents a reasonable fund. In this case, if your expenses averaged $4,458 per month, you should keep at least $13,374 in your fund. For adults with dependents or those with variable income, six months worth of savings may be a better bet; if you or a family member have health issues or you're retired, you may want to consider saving enough to cover your costs for eight months to a year.
Wealth Planning: Building Up Your Fund
As a general rule, strive to put at least 10 percent of your paycheck into your emergency fund each time you're paid. However, this number may differ depending on your unique financial situation, as it's essential to determine how much you actually spend on living expenses per month.
When calculating expenses, consider items such as:
- Housing (mortgage or rent payment
- Utilities (phone, cable, water, electricity)
- Car payment
- Transportation costs
- Incidentals such as clothing, toiletries, and entertainment
- Payments toward debt
When calculating these costs, remain realistic and be thorough. Underestimating your actual day-to-day living costs may result in a shortfall when you need it most.
However, saving too much isn't a good idea, either. Having that much cash sitting in a low-interest savings account means you're losing out on the chance to invest those funds and build your wealth through compounding interest. Though peace of mind afforded by a larger emergency fund may sound attractive, the key lies in finding the right balance.
While three to six months worth of living expenses is a good start, take the time to personalize your emergency fund goals to meet your individual financial needs. Most importantly, though, is to start an emergency fund. Even if you start small, making regular contributions — setting up an auto-deposit from your paycheck is a painless way to keep up — will allow your fund to grow and be there when you need it.