Finance specialists are of the opinion that you should have at least three to nine months’ worth of your monthly living expenses in an emergency fund. Well, new schools of thought have emerged and ruled that out, claiming that such funds are either excessive or insufficient to cater to the expenses that one would have to incur in emergency cases. So, how much should your emergency fund be and when should you use it?
Use Online Calculators
Just like it would be unwise to trade forex online without the use of tools like CMC markets, you need to use online calculators to come up with the right emergency fund amount. These are simple to use because you just need to input the figure of your earnings over a certain period and provide quick answers to some basic questions. The figure you get at the end of the process represents an approximate amount that you should have in an emergency savings account.
The 3, 6 and 9 Month Rule in Detail
- Three months– if you are a single individual who has a steady income and could move back into your parent’s home without notice, your emergency savings account could be sufficient if it is equivalent to 3 months’ your earnings.
- Six months– it is the most common savings plan and is favoured by married couples with kids who own homes and have consistent earnings. Also, couples who have no kids but are required to pay mortgages can also save an equivalent of six months’ their incomes.
- Nine months– full-time freelancers, self-employed individuals or persons whose incomes are unpredictable should maintain such emergency funds.
When coming up with an amount to save in an emergency fund, there is a need to give thought to certain important aspects. The presence of a reliable “safety net” that includes close friends and parents who can help out when times are bad can influence the amount that you should save. Others include:
- The marketability of your skills
- The stability of your job
- Possible emergencies such as health concerns in the family
- Combined household income
- Other assets in the ownership of a household
- The proportion of monthly expenses in relation to income
How Much Is Excessive?
According to various finance specialists, anything more than six or nine months’ savings in an emergency account is wasteful. The reason is that the excess would better be invested in a vehicle that could bring in interest or dividends. So, quit keeping too much money in an instant access or current account in the name of building your emergency fund. It is best to move the extra cash somewhere it could work harder for you.
Take care not to lose the value of your emergency fund cash to inflation. The right strategy, therefore, would be to save it in an account that earns at least 1% in interest per annum. Not that over-contributing to an emergency fund can also lead to the neglect of retirement accounts that are highly tax-advantaged.
When Do I Use My Emergency Fund
The term emergency obviously means different things to various persons, meaning that some may utilise their saved cash even if they encounter the slightest of financial problems. So, what is the proper definition of an emergency for this purpose?
A job loss, medical emergency, repairs to your property that result from a storm or other natural calamity fit the bill of an unexpected occurrence perfectly. Expenses that recur from year to year like Easter and Christmas shopping sprees should be planned for; and therefore, should not prompt you to withdraw from the emergency fund.
You also need to make a clear distinction between needs and wants. A broken car or a pest invasion do qualify as emergencies, and require immediate attention that includes making withdrawals from emergency funds. A renovation exercise that is meant to beautify your home in readiness for your upcoming wedding or graduation is, however, not a need but a want.
Determine if the issue at hand can wait before thinking of touching the funds in an emergency fund. A dental operation that is made necessary by injured gums cannot wait, so such a procedure has to be carried out immediately. On the other hand, the big sale at your favorite appliance shop does not mean that you should use your emergency fund to upgrade your refrigerator to the latest digital model.