I know the conventional wisdom says I should hold three to six months of expenses in an easily accessible account in case of an emergency or unemployment. At what point does that advice no longer make sense and it would be better to put that money somewhere it can earn more income?
For instance, if I’m saving up for vehicle repairs, house maintenance, and have a line of credit then does it still make sense to hang onto six months of savings rather than invest?
As the question suggests, the conventional wisdom is to have an emergency fund to handle situations where you either need to spend a lot of money at once (an emergency) or you no longer have a steady source of income (typically due to unemployment). The general rule is to keep enough money on hand so you could be unemployed for three to six months and still get by without going into debt. This is a good suggestion as most emergencies (broken cars, unexpected travel, and household fixes) can be covered with six months worth of income or less.
As with all general guidelines for life, this advice of keeping three to six month’s worth of savings is an estimate and what is best for you will vary depending on your situation. For example, someone who lives rent-free with their parents while making $200k per year will probably have very little need for an emergency fund. There isn’t likely to be any situation where this person would need $100k (six months of salary) to cover unemployment or an emergency. On the other hand, if you’re making around $25k per year and supporting both a spouse and child on this single income, the emergency fund should probably be over the prescribed $6k (three month) mark.
Do you have pets? Then the emergency fund will probably need to be bigger? Do you have multiple cars you and your family drive? Then the fund probably needs to be larger. Are you the sole income earner in the home? Then your fund should be bigger. If you live in an area where jobs are plentiful and you’re unlikely to be unemployed for more than a month then your fund can likely be smaller. If both you and your spouse work, ideally in different fields, then your emergency fund can probably be smaller because you can support each other. If you have investments you can withdraw without significant penalty then your emergency fund can be smaller.
In short, emergency funds are a sliding scale. How large your fund should be will vary depending on your lifestyle, income, how many streams of income your home has, and how many people (and pets and vehicles) you will need to support if you become unemployed. Typically the income you’d make in three to six months is a good starting point. But then you should adjust this amount up or down depending on your situation and comfort level.
Comments are closed, but trackbacks and pingbacks are open.