How much should you save in an Emergency Fund?

While the pandemic may have been an “unprecedented” event, unfortunately, the need to have an emergency fund is not.  

What is an emergency fund?

Emergency funds are savings set aside to tide you over in the event of financial shocks: 1. emergencies that require more spending than usual, such as for medical emergencies or home / car repairs, and 2. when your income is reduced with little notice, such as due to a layoff or reduced working hours.  

A misnomer? 

You may be thinking why are you defining emergency funds? It’s in the name! Some people actually disagree with the term “emergency fund,” because a lot of the events that an emergency fund is supposed to cover can be expected to occur routinely as a part of life. It’s just that when these events will occur is difficult to predict. Houses and cars routinely require maintenance, and statistically, most people will have to take an “unexpected gap from work” (1). Over one-third of these “unexpected gaps” in employment are due to layoffs (1).  

Perhaps then, you should expect to have to dip into your emergency fund to cover an unpredictable financial shock. A survey of U.S. households found that regardless of income, 60% of households experienced at least one or more financial shocks from 2014-2015. The average household spent half a month’s income on their most expensive financial shock. (This came to about $2,000 for the median household, but higher-income households had 3X more expensive financial shocks than lower-income households). Without an emergency fund, it can be really hard to recover from a financial shock. Most households that Pew surveyed “struggled to make ends meet” six months after the financial shock (2). 

Alright, I need an emergency fund! How much should I save?  

It’s okay to start small. Saving anything is better than nothing. Even $5/week can add up.

While saving anything is better than nothing, a survey of 5 banks suggests as a general guideline, that an emergency fund should be able to cover 3-6 months of expenses. (3,4). Given the current COVID-19 pandemic, I would say you should aim for 6-12 months of expenses. Emergency funds should cover critical expenses, but do not have to cover nonessentials that you can eliminate during lean times.  

Critical expenses:  

• Housing 
• Food  
• Health care, including insurance 
• Utilities / Internet / Phone – (electricity, gas, water, sewage, and trash and recycling) 
• Transportation / gas, including car insurance 
• Debt

Nonessential activities that emergency funds commonly don’t budget for include:

• Entertainment 
• Dining out 
• Nonessential shopping 
• Vacations 
• Savings for other goals 

You can adapt this guideline to your own situation by considering whether:   

• You have fewer social safety nets: Are you the only potential breadwinner of your household? Are you eligible for severance or unemployment benefits? (note: it may take weeks to get unemployment benefits, particularly if lots of other people are filing for benefits at the same time!) 
• Dependents? Do you have children or beloved pets? Make sure to factor them into your emergency fund!  
• How stable is your job? When you think about this, think about the stability of your company and industry. Is your company shrinking? How easy would it be for you to find a new job in the same industry if you were laid off? One of my friends has two jobs as a personal trainer and in the airline industry. She always thought of her airline job as a backup – but both of her jobs were affected during the COVID-19 pandemic. In general, highly paid individuals with very specialized jobs, who have worked for the same company for a long time, find it more difficult to find an equivalent job with a new employer. (3). 
• Macroeconomic factors – if a recession is imminent (or current!), it may be harder to bounce back from job loss. According to the U.S. Bureau of Labor, it took on average, 9.2 weeks for people to find a new job after a period of unemployment. Now that we’re in the midst of a pandemic, it’s taking people an average of 13.6 weeks to find a new job (5).  

Where should you stash your emergency fund?  

Some people like to keep their emergency fund in cash. That’s fine. But if you’re erring on the conservative side and keeping over six months of savings in cash, you may be missing out on an opportunity to grow your savings. Consider keeping 1-2 months’ worth of expenses in a high-yield savings account and keeping the rest of your assets in easily accessible, liquid investments such as money-market funds, certificates of deposit, and short-term bond funds.  

Final Thoughts:  

Everyone experiences financial shocks during their lifetime, but an emergency fund can mean the difference between a manageable hindrance or a major obstacle. You don’t have to create your emergency fund overnight but challenging yourself to save more may prevent undue financial hardships in the future.  

Summary:

• Expect that you will have to use your emergency fund.  
• An emergency fund of 6-12 months’ worth of expenses can turn financial shocks into a manageable setback. 
• An emergency fund should consist of liquid savings, but that’s not necessarily pure cash! 
• Anything is better than nothing – start saving today! 

Sources: 

Image courtesy of www.ccPixs.com, licensed under CC BY 3.0.

1. Monster, “Monster’s 2019 State of the Candidate Survey.”
2. Pew Charitable Trusts, “The Role of Emergency Savings in Family Financial Security: How Do Families Cope with Financial Shocks?”
3. Vanguard, “Break glass in case of emergency: Managing household liquidity.”
4. Fidelity, “Preparing for Emergencies;” Chase, “Saving for an Emergency: Are You Prepared?;” Wells Fargo, “Saving for an emergency;” Goldman Sachs: “Emergency Fund: What It Is And How To Build One.”
5. Federal Reserve Economic Data, “Median Weeks Unemployed.”