much do I need in an emergency fund?
by David Berky
Downsizing, rightsizing, forced
retirement, layoffs, firings, outsourcing, and being
All could mean the same thing to you: financial catastrophe.
No, you may not have to declare bankruptcy or move back
in with your parents, but losing your job could put
a big dent in your financial goals and even set you
back several years. You may need to live on your savings
or liquidate some of your investments.
If you have no savings or investments you may have to
rely on credit cards and could rack up significant credit
card debt. Then when you find a new job, your expenses
may have increased because of the additional credit
And the job you eventually find may not pay as much
as the one you lost. So you are now forced to live on
less while your expenses have either continued at the
same level or even gone up.
Studies show that the average worker will have six career
changes in his or her lifetime. Not just job changes,
but career changes.
So how can you prepare for your own financial "downtime"?
An emergency fund.
An emergency fund is really just savings. But it is
not savings for a particular item or even an investment
for your future or your retirement. It is your "rainy-day"
fund. But unlike insurance where once you pay your premium,
the money is out of your hands, your emergency fund
is yours to keep.
So how much do you need? How can you build your emergency
fund? And where should you keep the money?
The easiest way to figure out how large your emergency
fund should be is to take your current income and multiply
it by the number of months you could be out of work.
If you make $3,000 each month and you want to be prepared
for a 6 month "vacation", you will need $18,000.
But obviously saving $18,000 will take some time. How
quickly you want to build your emergency fund depends
on how concerned you may be about your current and future
Saving $100 each month will take you 180 months or 15
years. Saving more each month means you will be protected
sooner. Also consider that during the next 15 years
your income may increase and your expenses usually rise
to match your income.
Also consider inflation. (If you own your home, your
house payment may not rise. If you are renting, your
rent probably will.) The cost of food, utilities and
taxes also rise over the years. At a 3% inflation rate
after 15 years your $18,000 will only buy $11,400 worth
A good rule of thumb for saving is to try to save enough
each year to supply you with one month's income. This
means you are saving 1/12 or 8.3% of your monthly income.
This will allow you to build your emergency fund by
one month every year. After only six years you will
have a six-month supply of emergency cash. Then you
can continue to extend your "coverage-period" or you
can divert the monthly payment into other savings or
Most people find that "billing" themselves for savings
and investments is a good way to put your savings on
auto-pilot. If an amount is taken automatically from
your bank account each month, it is easier to handle
than if you wait until the end of the month and try
to save from what you have left over. (How often do
you have anything left over?)
So where is the best place to keep your emergency fund?
Probably not a place where you can have easy access
to it - too tempting. Definitely not as cash in the
cookie jar - too unsafe (and no interest). And probably
not in 5 year CDs - too restrictive. You may want to
avoid CDs altogether so that you are not charged an
early withdrawal penalty when you can least afford it.
Savings accounts are OK, but usually pay very little
interest. If a savings account is your choice, open
one at a bank that you don't regularly use. Also don't
get a checking account to avoid the temptation to spend
"just a little" bit here and there.
Or look for a money market account that pays a reasonable
interest rate. You may want to consider a money market
account that only invests in tax-free securities. This
way you won't have to worry about paying taxes on your
Then set up an auto-withdrawal from your regular checking
account or direct deposit amount from your pay check
right into this new account. Adjust your budget to accommodate
having less money each month and forget about it.
You can also give your emergency fund a boost now and
then by putting "windfall" money into to it. You know
"free-money"; birthday gifts, inheritances, insurance
settlements, escrow overages, rebates, tax refunds,
Your emergency fund becomes your own financial insurance
policy. And if you never use it you will have that much
more money to play with when you retire. Or even retire
early with the extra money you have saved.
© Simple Joe, Inc.
David Berky is president of Simple
Joe, Inc. a marketing company that sells simple software
under the brand name of Simple Joe. One of Simple Joe's
best selling products is Simple
Joe's Money Tools - a collection of 14 personal finance
and investment calculators. This article may be
freely distributed so long as the copyright, author's
information and an active link (where possible) are