Emergency fund – how much do we need?
You lose your job. You’ve no heating or hot water as your boiler has just broken. You’ve a pile of wet clothes stuck in the washing machine and a heap of dirty laundry piled up waiting their turn. We’re talking nasty, undesired events that crop up causing a massive financial headache, a sick feeling in the stomach, anxiety and worry. All of these things, or variations of, happen to all of us. It’s not really a question of if it will happen, just which scenario we’ll be facing and when. It’s the disaster-planning part of our finances, our emergency fund, rainy-day fund, whatever you call it. Cash we have put to one side that we can call upon at short notice to dig us out of a hole. It keeps us in the black as we can avoid resorting to borrowing on credit cards or taking out loans, and helps us to sleep at night in the knowledge that we’ve done what we can to cope with financial disasters as they’re thrown at us.
Do we need one?
I need no convincing on this one. I fall squarely into the cup-half-empty camp. Witness this blog, set up out of worry about what will happen if I don’t do something to build up my retirement savings between now and then. I’m employed, but have been and am currently again in an environment where redundancy threatens. I see people around me losing their job, and am under no illusions that I’m indispensable. I work hard, do my job well (I think, so I’m told!), but even if I meet and exceed targets, should the time come that the spotlight-of-doom turns to me and my department, it’s outside of my control if someone far higher up in the corporate tree decides the numbers don’t add up. The axe could quite easily fall on my head, and I’ll be in the position facing many others of working out what to do next.
It surprised me that it’s not the only way of thinking, as some feel that having an emergency fund stashed away makes no financial sense. Insurance covers many emergencies – medical emergency? Health insurance kicks in. Household emergency? Contents and buildings insurance pays out. If you’re employed, and might receive some kind of illness benefit, or redundancy pay-off, in a worst-case scenario you’ll have a bit of money behind you to help in the early stages. Then there’s the argument that keeping large sums of money in low-interest savings accounts makes poor financial sense (and if you’re cautious and want to keep more behind you, this applies especially to you), rather it should be invested and earning returns that hopefully at least keep pace with inflation.
Arguably it’s those with the most debt and least disposable income that most need an emergency fund. If you’ve a lot of disposable income per month, and can more easily build up such savings, you can more easily weather unexpected costs.
3-6 months of expenses?
Assuming you decide you’d like or need to keep some money to one side, how much should you aim for? Ignore any money you currently save, and ignore luxury items that you’d knock on the head should you be in an ‘emergency’ scenario, and most advice seems to sit somewhere between 3 and 6 months of living expenses. Some recommend up to a year of expenses though. The answer seems to be whatever you feel comfortable with, taking into consideration your personal circumstances. For example, if you’re a two-income household, or have more than one income stream, maybe you need less than if you’re trying to limit the impact of losing your job if you’re the only person earning money in your household. If you’re self-employed, have large fixed expenses, a large income, are over 50, maybe you’d find it harder to get a new job?
For me, losing my job is the fear-scenario. I feel better placed emotionally to handle other types of unexpected expenses, but I’ve been in jobs I’ve hated before and finding employment that fulfils and makes me happy, as well as paying the bills, is not the easiest of things. I don’t want to be rushed into jumping into any job I can find out of necessity, rather I’d like to do so from as calm a mindset as possible, taking time out if needed to reconsider my options.
How long to find a new job?
The emergency fund calculator on www.moneyunder30.com asks how easy you predict it would be to find another job. If you think you’d easily find another job, it suggests you may be unemployed for 3 months. If you consider you’re well qualified for many jobs, and it would take an average amount of time to find a new one, then you could be unemployed for 6 months. If you move to scenarios where you’d maybe find it difficult or very difficult to find another job, either because you lack the right skills or work in a field or at a salary level where positions are limited or competitive, then maybe you should envisage a period of unemployment of 9 months to a year.
In either of these scenarios, when you actually add up in monetary terms how much you’d need put to one side, if you’re planning for over 6 months of expenses in an emergency fund, it works out at A LOT OF MONEY built up in a savings account! As well as inflation eating away at your money, it would take a lot of time to save for this. Alvin Hall, in his ‘Your Money or Your Life’ book, advocates aiming for 4-6 months of after-tax income or living expenses. However, he also recognises that this could take many years of saving to achieve. Apparently, he says that if we save 10% of our take-home income, we could achieve a 4 month emergency fund in 6 years. Similar to other advice I’ve read, he says start small. If 10% is too much to begin with, save what you can, and don’t be daunted by the scale of the task in hand – rather he says it should be viewed as a major lifetime achievement that is worth working towards over several years. You could also aim for an initial savings buffer to cover smaller emergencies, rather than aiming for your ideal scenario all in one go.
In an ideal world, being the cautious, worst-case-scenario kind of person I am, I’d like 9 months to a year of expenses behind me. However, in addition to the time it would take to accumulate, and bearing in mind my desire to sort my long-term retirement savings, it seems too large a sum to have sitting in cash. For that reason, combined with the fact that if I were to lose my job I’d receive 3 months money and hopefully some redundancy pay, I’ve decided that 6 months is enough. Which leads me to the next question – just how much is enough when it comes to my retirement savings?
Ending on a positive note (before the gloom of seeing the answer to the above question!), Which? notes that in addition to giving you security against a disaster, having an emergency fund also means you can be impulsive should a good opportunity come along. Which can only be a good thing, and motivation to start / keep going should we need it!
Image: Pixabay: darkmoon1968