This question has been debated by financial experts time and time again. How much money should you have in that rainy day fund? What is the magic formula?
- Dave Ramsey has recommended saving 3-6 month’s worth of expenses after all non-mortgage debt is paid off.
- Suzy Orman has recommended saving 8 month’s worth of expenses before paying off credit cards.
- David Bach has recommended saving at least 3 month’s worth of expenses by automatically depositing [5%] into a savings account.
While all of these are great suggestions, it can still be difficult to know exactly what to do given the vast amount of advice.
Then comes the faith issue. Some Christians have questioned having an emergency fund because it could lead to trusting in money rather than God. Bob tackled this problem in a great article entitled, “Would Jesus Have An Emergency Fund.” I highly recommend you read it if you are struggling with this issue.
Once you have decided you should have an emergency fund, the question of how much money you need inevitably comes up. To answer this question effectively, we must consider the PURPOSE of an emergency fund. It is obvious that this fund is for emergencies . . . but what kind of emergencies?
A Few Emergency Scenarios:
- Your household income stops (aka, everyone loses their jobs). Estimate how long it will take everyone to find jobs again.
- Medical issues arise. Medical bills are one of the leading causes of bankruptcy in America. If you were to have major surgery, how much do you think that would cost? To curb costs, make sure you have great health insurance.
- Home repairs are needed. If your septic tank goes out, you might have to dish out thousands of dollars. If your home gets flooded or catches on fire, damages can be widespread. Of course, it’s important to have in place great homeowners insurance.
These are just a few of the major issues that can arise. There are many more smaller expenses that might be considered emergencies. For example, check out some of our emergency expenditures from last year.
No Magic Formula, Just A Customized Plan
The truth is that there is no concrete magic formula. Everyone’s emergency fund will be different. However, there are some great rules of thumb to follow. I’ll share with you how my family saves and the goals for our emergency fund.
First, we are currently building 6 month’s worth of expenses in an ING Direct Savings Account. Although we can probably get by with a 3 month emergency fund, it gives both my wife and I great peace of mind knowing that if a doozy of a storm hits, we’ll be okay. 8 month’s worth seems excessive at our average income level (we have variable income). The ING Direct Savings Account is very liquid as well, which makes it easy for us to transfer money to our checking account should an emergency arise.
Second, we chose to put that emergency fund in ING Direct so that it could be labeled for “emergencies” and nothing more. This separates it from our brick and mortar bank so that we aren’t tempted to use it for non-emergencies.
Third, we take any extra cash we have and throw it toward the emergency fund. We have not chosen to automate our savings because we feel that it would give us an excuse to spend extra cash elsewhere. This results in us putting in between 10 and 20% of our income (varies month to month) into our emergency fund. We will continue at this rate until the emergency fund is fully funded.
The location, size, and monthly contribution amount of your emergency fund will likely be different from ours. There will be times in your life where it is better to eliminate debt rather than contribute to an emergency fund. There will also be times in your life where you need to severely cut back your spending so you can pile up cash for a pregnancy or other significant life event.
Everyone should implement a plan to build an emergency fund. The details are up to you. But make sure to take your umbrella out! It will rain sooner or later!
The prudent see danger and take refuge, but the simple keep going and suffer for it. -Proverbs 27:12 NIV
How much do you have saved in your emergency fund? What other emergencies are you saving for?
Photo by wayne.vernon