How Much Should My Emergency Fund Be ?

Emergency funds are dynamic accounts that range from $2000 equivalent to a hospital E.R visit up to 6 months of expenses in case of a job loss.

Typically they are left in a savings account earning 2% interest. Keeping your mind at peace against inflation . It’s meant to give you a feeling of safety in case something bad happens telling you everything’s going to be alright.

One of the more alarming signs of our country’s financial troubles is shown in a study done by the Federal reserve that showed that four out of ten adults cannot afford an emergency over $400. 

There are a multitude of reasons and all are correct, but ultimately, are not important in our discussion. What we want to focus on is: How do we fix the situation? we always recommend common sense financial education and action.

How do i start building it ?

It needs to be incremental. Start saving $200 from each paycheck and work you way up to $1000-$2000.

Then you increase that in a stage by stage process all the way up to 3 to 6 months worth of your expenses.

This should all be done in tandem with getting your companies matching 401(K) to get free money , and also paying off any outstanding debt. For more information on how to do this read here.

This insures you are achieving three things at the same time : paying off debt , investing , and building your emergency funds. We recommended not to neglect any one of the three. While two preserve the present, the retirement account will also preserve the future. 

These Funds should be held in a high yield savings account like Ally banking , or wealthfront.

What should the emergency fund be used for

A Full 3-6 Months worth of expenses is a lot of money just parked in a savings account. But it is also going to be very important if some big expense pops up e.g H-VAC unit replacement, a car wreck, an unexpected hospital visit.

They are not often, and they might not happen for five or ten years sometimes. But having your funds in a high-yield savings account waiting is the smart way to go.

The right way to picture this is as part of your budget. You are planning a $200 expense every paycheck for “X” and instead of paying it all in one go , you are making monthly payments to this account for the future. 

Now when “X” is a car wreck , and you prepaid $200 for a certain amount of paychecks. immediately you can pay it off without worry and admire your brilliance for planning for this future event.

This is a common tactic among real estate investors. They plan major repairs years ahead of time by incorporating a certain amount of cash held in a savings account until a major repair happens e.g repairing a full roof for $8,000.

This amount is factored in the calculations for rent when trying to figure out if a property is cash flow positive . Read about it in a future article.

If you don’t need to use that amount of money there are ways where you could invest into a low risk bond or a low risk portfolio and just keep it until you actually need to use it.

When do you start building it ?

Typically you should start immediately. As soon as you have your first paycheck, that includes teenagers, you contribute to this fund every month.

As we mentioned earlier, you can go about this incrementally by contributing from every paycheck $100-$200 and dividing it up over a couple years. 

The other method; saving it all continuously for a couple of months, until the fund is maximized.This method ensures the quickest route. 

The only thing to note here is this method works best if:

• you have no debt, which takes priority over investing.
• Make a decent paycheck every month, over $2000 in savings after expenses. 

This is to ensure you take advantage of opportunity cost of your money. 

Best practices

we recommend first, get the company matching for 401(k) set up. Afterwards, what’s left from the paycheck, will grow the emergency fund parked in a savings account. 

Of course don’t forget to pay off your debt in the avalanche or snowball method we mentioned in an earlier article.

The reason you want to do it this way is Time.

Eventually the fund will be maxed out, but what is the point if the credit score is hurt ? what if it takes a couple years, and you missed out on significant investment profits because you didn’t invest early ? 

It is best to multitask all of these together to get the most benefit from your finite time.

Also, you must avoid using your full emergency funds at all costs, even if it is for investments. Since you cannot predict the future if a recession, downturn, correction happens. 

The emergency fund is also used for those cases when caught off guard with investing. You can live of those savings without dipping into your investments and hurting your retirement.

After you have a full 3 to 6 months of expenses

When you have six months worth of expenses, all that extra money saved up, can be deposited directly into retirement accounts.

Of course you could also save for other events you might want to do like a vacation during the year . Just be sure not to use your emergency funds for this vacation. Use your savings from your paychecks incrementally throughout the year to budget for the vacation well ahead of time.

The best we recommend is to pay off any remaining debts. In essence, the emergency fund money will always act as a cushion in times of need. Any extra, you can use to pay off other substantial debts.

By doing this method, you will find yourself sleeping better at night. And in the worst case scenarios, you will have at least six months of expenses all covered..

Thank you for reading !