Yesterday I had a post up on Millennial Money Man, breaking down why increasing your savings rate isn’t just useful for early retirement! If you’re new here thanks to that post, welcome, and if not, make sure to check out the post and send M$M some love!
Back to what appears to be my current favourite topic: emergency funds. As I mentioned when I broke down how emergency funds make getting fired way better, today I’m going to be tackling the age-old question.
How much do I actually need in my emergency fund?
I think I’m closer to Average Jane than Pro-fresh-ional Personal Finance Blogger when it comes to my emergency fund, considering that literally as I write this sentence, I don’t have a set goal for my emergency fund.
I just never sat down to really look at it.
Consequently, I have no idea how much I really need to save in it.
Don’t get me wrong, I’ve always contributed to it monthly, and it has saved my butt so many times, including my recent $458 lesson in how to adult properly. But it’s never been like, a planned, intentional kind of thing.
So if that’s the boat you’re in, welcome. We can do this together. For all my super-duper responsible friends… I’ll see you on the other side.
Here are the three questions I’m working through to set an appropriate emergency fund goal.
1. What’s your emergency fund for?
This seems like it should be an easy one. Emergencies, duh.
But some people take a really hard line on this. They’ll tell you that emergency funds are for something catastrophic that causes a multi-month loss of your regular income, like getting fired or a sudden illness. That is an amazing, worthy, worthwhile stance, and if you’re going for an A+, this is what you should aim for.
What if I want more of a solid B+ or an easy A at this stage of my life? What if I want a bit more flexibility in terms of what my emergency fund is really for?
Personally, I think that’s OK, especially when you’re in your 20s.
In an ideal world, yes, you would have separate savings accounts to cover every potential setback, like car repairs, or a $458 ticket for forgetting to renew your license plate. But when you’re in the middle of the most expensive decade of your life, and you’re trying to balance multiple savings goals, maybe some wiggle room is called for.
That said, calculating how much you want in your emergency fund will need to take this into consideration. If this account is only for covering your costs for a set number of months, it’s easy to calculate. If, on the other hand, this also might be your “The air conditioner broke down and it’s a billion degrees in here” account, you should add a little extra.
My Emergency Fund Answer
I’ll be drawing on this account to cover big unexpected expenses that aren’t already planned for in other accounts. I’ve got accounts to cover big home purchases, doggie emergencies, vacations and gifts, so my emergency fund is officially for:
- Unexpected car expenses
- Loss of income for a few months
2. What might an “emergency” cost?
Before I get into the loss-of-income side of the calculations, I’ll take a look at what my unexpected car repairs might look like. There are three kinds of car issues I consider emergencies: major accidents, unexpected repairs and simple mistakes that end up costing an arm and a leg.
- My current car insurance has a $500 deductible, but I’ll be switching that to a $1000 deductible when it comes up for renewal in April. I’d like to be able to “self-insure” for a bit more than that, so for major accidents, I’ll aim for $1500 in my emergency fund.
- I’ve got another 10,000KM before my next major service appointment, but given my experience with those, they’re when the big expenses tend to pop up. I’d like to save $2000 in my emergency fund specifically to cover things like replacing the brakes in the vehicle, if and when it comes to that.
- Lastly, I’ll add $500 to cover the unexpected things that pop up, like the $458 reminder to renew my license plates.
My Emergency Fund Answer
I’ll be tacking on $4000 to my emergency fund goal to account for the fact that it’s my backup for car repairs.
Now to calculate how much I want to save in case I lose my income.
3. How much do you spend every month?
I’m a huge proponent of tracking your income, because you could be spending $4000 a month and have no idea where all the money went. This is a true story, by the way, as I learned when I looked back at my Mint reports for the past year. Last February was a $4000 month, and I couldn’t tell you a single thing I bought in that time. And February is barely even a real month for crying out loud.
As they say, knowledge is power. And until you know where your money is really going, it’s hard to make any kind of adjustments or improvements. You might think you know what you’re spending, but you could be wrong.
Once you do know, though, it’ll make calculating an emergency fund goal easy peasy. All you need to do is choose the number of months you want to be able to sustain your basic needs, multiply it by the amount you spend on average each month, and if you want to be generous, assume you’ll spend 80% of your currently spending level, because you’ll be all jobless and stuff.
My Emergency Fund Answer
As an average figure over the past few months, even with some unavoidable expenses, I’ve managed to keep my spending hovering right around the $2000 mark each month. I’d like to have my emergency fund cover 3 months of expenses to start with, and giving myself the 80% grace calculation, that brings me to $4800.
So, what’s my emergency fund goal?
Given these calculations, my current emergency fund savings goal is $8800.00. I’m really glad I did them too, and here’s why.
Since I have an undying love for spreadsheets, I built one to track how my current savings rate will play out over the next few years towards my different goals. Once I hit $5000 in my emergency savings account, I did some quick spreadsheet magic and had that monthly amount transferred to my house downpayment fund, effectively capping my emergency fund and marking it as “done” in my future mind.
But clearly, that was a bit of spreadsheet magic I should have skipped.
Taking a clearer look at what an emergency fund means to me, and what I’ll use it for, gave me a much more realistic number to work towards, and that means keeping up my monthly contributions until I hit that $8800.00 number.
That’s ok, because when an emergency comes around, I’ll be happy we had this chat.
What about you – are you an A+ personal-financer and have a fully funded, untouchable emergency account? (I’m so excited for you if you are, and you should be immensely proud of that!) Or are you still working towards one like me? Let me know!