If you’ve decided to begin saving money for emergency situations in life, you’ve made a very wise step. But as soon as we dedicate ourselves to emergency savings, a question arises: How much is enough?
There are a variety of different answers out there. Perhaps the most honest one would be “No one really knows,” because it’s impossible to truly predict how expensive an emergency will be. A number of good guidelines and rules of thumb help to point us in the right direction… but even then, it all depends on your unique life situation.
The dilemma with emergency funds is this: Save too little and you leave yourself under-prepared when emergencies strike. That can leave you exposed to debt and other dangers. But if you save too much, you’re shorting yourself in the long-run, because you could have invested that excess money to build wealth, or given it to a good cause. We must be careful not to let fear get the best of us… if we do, we might end up with stingy hearts, sitting on top of piles of money that could be put to better use.
So, how do we determine how much money our emergency funds should hold? Well, if the point of these funds is to pay for emergencies, maybe we should start by forecasting what kind of financial emergencies we’re likely to face. And though nobody can see the future, there is a lot that we can predict pretty well. Much of it has to do with what stage of life you’re at — in the same way that insurance actuaries predict your chances of dying or having a car wreck based on your demographic picture, we can make a lot of predictions about the dangers we face in life based on our age, profession, family responsibilities and other factors.
So, let’s look at potential life emergencies, starting with young adults and progressing through life:
College Students/Young Adults
If you’re a student, you may be living with some kind of financial support from your parents, even if it’s simply in the form of their cell phone plan, health care or car insurance policies. So, what sorts of emergencies might you face?
- Car mechanical problems — It can cost several hundred dollars to repair your auto. If it’s more than $1,000 or so, you’ll likely do better by simply replacing the car.
- Medical bills — Since you’re young and healthy, the chances of you having a lengthy medical issue or hospital stay are low. You should plan on being able to take care of several hundred dollars worth of medical problems. But the kind of freak car accidents that would put you in the hospital are covered by auto insurance.
- Miscellaneous emergencies — Other random things may happen, but they’re not likely to add up to great expenses.
- Total recommended emergency fund: $1,000
At this stage in life, you’re hopefully beginning in a career. But you may still be renting a house and driving a cheap car. If you have a nicer car, you need to be prepared to spend more on repairs. Your medical liabilities aren’t much greater than they were when you were in college. And since you rent, you don’t have to worry about paying much for home repairs.
The biggest risk at this point in life is job loss. If you lose your job, you’ll still have to pay rent, feed yourself, put gas in your car and cover your utilities. You can probably find another job within about three months (even if it’s just a temporary gig waiting tables), so you should have enough emergency savings to live frugally for that much time
- Total recommended emergency fund: Three months worth of expenses, or around $5,000.
This is the point in life where emergency expenses can come out of the woodwork and add up fast.
- Home Ownership — If you own a home, you know that emergency repairs can come up out of nowhere. Depending on the age of the home and its systems, you may have to pay up to $5,000 or more to replace an HVAC system or roof, or to fix major plumbing or electrical problems. Bigger expenses resulting from emergencies may be covered by your homeowner’s insurance.
- Dependent Care — If you have a spouse or children, your potential for emergencies rises exponentially. When you were single, you only had to worry about yourself. Now that you’re married, you may have two cars that could wreck or break down. And pregnancy, childbirth and your kids’ illnesses can stack up to big medical bills. A medical incident could cost you $5,000-$10,000 or more out of pocket, even if you have “good” health insurance.
- Job Loss — A job loss at this point in life can hit you really hard. Since you have more monthly expenses and mouths to feed, grabbing a quick, low-paying job may not be enough to cover your bills. That means that you may have to spend six months or more looking for your next job.
- Total recommended emergency fund: Six months worth of expenses; or around $10,000 for a couple, and $5,000 additional for each child.
Of course, these numbers are just guidelines — they’ll vary a lot based on factors like your income and lifestyle, the part of the country you live in, and any special circumstances that your life presents. So don’t get too fixated on the specific figures. Instead, use some of the reasoning and thought process to determine what a good emergency fund will look like in your life… and then work hard to save enough money to get there.
Photo by Juan Camilo Trujillo. Used under Creative Commons License.