Today’s article is a follow-up to another post, “5 Key Reasons to Establish an Emergency Fund Now,” which explained why you should have an emergency fund. As promised, I will now describe the factors one should consider when determining the appropriate size of an emergency fund. One overarching consideration is that an emergency fund should be just large enough to accomplish its purpose and no larger. By its very nature, an emergency fund should be kept in a bank savings account. The bank should be a prominent institution with FDIC insurance. The unfortunate byproduct of safety is low-interest rates on deposits. An emergency fund that is too large means that money is left on the table, not working for its owner.
So how much money should be in an emergency fund? I’ll start with the rule of thumb: three to six months of emergency expenses. Once past the rule of thumb, I’ll explain how to factor in insurance deductibles and copays and, finally, how to view individual and total risks that increase or decrease the size of the emergency fund.
Start with 3-6 Months of Expenses
Why three to six months? The idea, at its most basic level, is that most people should be able to find new employment in three to six months if they lost their job. A realistic assessment during most normal economic times, it means that lifestyle doesn’t change drastically during the period of unemployment. Three to six months is a wide range, though. Individuals in a high turnover industry should be more conservative with a more significant emergency fund. The same goes for individuals who live in areas with struggling economies. On the flipside, people with skills in high demand or careers with relative security could get by with a smaller emergency fund. For my military clients, I tend to start my calculations with three months of reserves.
