Advice from “Financial Gurus” Can Lead You the Wrong Way
How to Size Your “Perfect-Fit” Emergency Fund
Your “perfect fit” emergency fund size depends on your personal situation; one-size-fits-all doesn’t work
Chances are, you know you need an emergency fund to survive financial emergencies.
However, if you research how big this fund needs to be, you’ll run into contradictory advice, much of which is wrong or at least incomplete.
The following is how I figure out how much I need to set aside, which should help you figure out your “perfect fit” emergency fund size.
Examples of Bad or Inaccurate/Incomplete Advice from “Financial Gurus”
Dave Ramsey suggests your emergency fund be $1000 (at least until you’ve paid off all your debts, which isn’t necessarily a great idea).
If your kid suddenly needs a cavity filled, your car’s alternator goes out, or something of similar magnitude happens, $1000 should be fine.
But that’s not a real financial emergency. It’s just life happening.
A true financial emergency is if, heaven forbid, you become temporarily disabled due to an accident or severe illness, or lose your job. If that happens, $1000 is not even remotely in the ballpark of enough to tide you over.
If $1000 is all you have saved up, you’ll run out of cash and out of options before the week is out!
Suze Orman, on the other hand, says you need to set aside 8–12 months of your income. While in some cases that’s true, it’s sort of like pulling an XXXL shirt off a store rack and saying that it will be large enough for you. Sure, that shirt will be a perfect fit for some, but it will be grossly over-sized for most.
Orman is right to state things in the number of months, but misses the mark in two important ways.
First, by saying that 8–12 months is right for everyone, and second by using your income as the measure of what you’ll need to replace.
To get the real number that’s right for you, let’s figure out how many months you need to worry about, and what number of dollars that translates to.
Your “Perfect Fit” Emergency Fund Size in Months
You can intuitively get that if you’re a single parent to several small children, have no family support, and your income is not a stable salary, your risk of a financial emergency devastating you is much higher than if you’re married, have no kids, both you and your spouse have well-paying jobs with stable employers, and if push came to shove, your family would help you out.
That’s why nobody should give a set number of months, whether it’s 3, 6, 8, or 12 months, or even a set range like 3–6 or 8–12 months.
We have to accept that any number of months short of the likely remainder of your life will not provide a 100% guarantee that your emergency fund won’t run out in any circumstance.
If you can create such a giant emergency fund, you can probably already retire, and don’t need my advice (in fact, maybe I could use yours ;)).
The problem is that almost none of us can create that size fund. That’s why you should look at your personal circumstances and decide on a range of months that makes sense given the following factors:
- Do you have to take care of others (young children, elderly parents, etc.) or have other financial responsibilities, or could you significantly downsize in a hurry if you’re hit by an emergency?
- Is your income stable and predictable?
- Do you have a spouse, significant other, or other family or friends who can and would chip in and help in an emergency?
If you’re married, both of you have stable incomes, you have strong family support, and don’t have a problem swiftly and sharply cutting expenses, you can probably make do with a 3–6 month emergency fund. For each factor where you’re on the riskier side, add 3 months to your personal number.
For example, if all the above is true for you except that you’re single, 6–9 months would be better for you.
If you have few financial responsibilities that can’t be swiftly downsized, but you’re single and self employed, 9–12 months would be your better bet. If you’re single, self employed, and have little flexibility in downsizing, shoot for 12–15 months.
Your “Perfect Fit” Number of Emergency Dollars per Month
The second critical question is what determines how many dollars you need to set aside for each of these months?
Certainly, if you can replace every dollar you earn, that’s best. However, that’s a much tougher target, and importantly, it’s more than you need.
Your real need is to replace only enough income to cover your critical spending. That includes:
- Rent or mortgage, unless long-term couch-surfing is an option
- Utilities
- Broadband Internet service (if you’re on a contract and/or you need it to bring in new income)
- Phone
- Groceries and supplies
- Insurance premiums (e.g., homeowner/renter’s, auto, health and dental)
- Medical expenses
- Property taxes (if any)
- Auto expenses (gas, maintenance and repairs, parking, tolls, loan payments if any, etc.), unless you can do without a car
- Debt payments other than auto and mortgage
- Other expenses you can’t reasonably do away with
You’ll immediately notice I didn’t include in these three major categories:
- Income taxes
- Savings
- Discretionary expenses.
That’s because if your income goes away, you don’t owe income taxes; you have no way to set aside money; and if push comes to shove, you should plan on cutting discretionary expenses as close to zero as possible, at least until you’re back on your financial feet.
Your “Perfect Fit” Emergency Fund Size in Dollars
Now that you’ve calculated how many months you need to worry about, and how many dollars you’ll need to cover per month in an emergency, multiply the two numbers.
That’s your “perfect fit” emergency fund size in dollars.
That number may seem undoable, but that’s ok.
You don’t have to get there tomorrow, or even next year. Just get started. Set aside some money from each paycheck, even if it’s only 3%. If you can’t do 3%, start with 1%. Anything can and will help. Then increase that rate each year by as much as you can.
In addition, each time your income increases, whether it’s from an annual bonus, a holiday tip, a big cash gift, or a raise, divert at least half to your emergency fund.
Once you reach your target number, don’t increase your spending.
Instead, use the money you would have sent to your emergency fund to turbocharge your other savings for goals such as retirement, down-payment for a house, replacing your junker car, college for your kids, etc.
By doing all this, you help your future self by (a) increasing the resources you have available to you, and (b) preventing your financial obligations from ballooning over time.
Disclaimer
This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the Author
Opher Ganel has set up several successful small businesses, including a consulting practice supporting NASA and government contractors. His most recent venture is a financial strategy service for independent professionals. You can connect with him there, or by following his Medium publication, Financial Strategy.
