An emergency fund is an important part of planning your money and goals in order to keep your financial health safe. Not to sound like Debbie Downer, but you never know when something will happen that disrupts your regular paycheck. Having a fully funded emergency savings account helps you weather a storm without having to go into debt or financial distress.
One quick note to I should mention. I’m not a financial planning professional. I’m sharing what’s working for me as part of my investing strategy. Always do your own research and consider your own circumstances before making any financial decisions. You could also check with your favorite financial professional to understand what would be best for your situation.
What is an 6 month emergency fund?
An emergency fund is a money you’ve set aside to cover unexpected expenses when life take an problematic turn. There are a lot of reasons why you need an emergency fund. Think about how you’ll pay your bills if your suddenly lose your regular paycheck because you were laid off or are unable to work any reason.
Or you suddenly have an expensive situation come up such as a medical emergency. While insurance will cover some of the costs, you probably have out of pocket expenses in addition to potentially not receiving your regular paycheck.
A 6 month emergency fund is an account where you have enough money saved to cover your bills for six months. While you can start with simply $1,000, you probably would run out of money quickly if you’re out of paycheck for weeks or months.
How much money should be in your emergency fund?
The common recommendation is that you should have 3 to 6 months of expenses saved in your emergency fund. You never know when life will take a problematic turn (such as being laid off from your job or an unexpected illness), resulting in not receiving your regular paychecks. That’s when you either dip into your credit cards to pay your bills or hopefully have savings ready and waiting to cover your expenses.
Ultimately the actual amount you should have in your emergency fund will vary from person to person based on your monthly expenses. Part of the decision will be determined based on how fast you think you’ll get back to a regular paycheck.
And your emergency fund money should be separate from money you save your regular bills. To help give you more breathing room on your regular bills, consider sinking funds set aside money to cover regular expenses.
2 steps to calculate your 6 month emergency savings goal
To calculate your emergency fund goal, start by figuring out how much you spend each month. Gather up all of your bills for everything from housing to car payments to utilities and food.
For example, let’s say all of your bills and expenses combined for one month is $3,000.
Next to determine your 6 month goal, you need to multiply your monthly expenses by 6.
Keeping with the example above, to have 6 months of expenses saved, you would set your emergency fund goal as $18,000.
That goal may feel overwhelming. I know my goal of savings 6 months of expenses was for me. While I previously started a small emergency fund, I put off building it to the full amount. A large goal will take a solid plan in order to make it reality.
To help make this more manageable, consider starting with building a 3 month emergency fund first. Maybe then take care of other financial goals and then return to building out the full 6 months. You’ll need to figure out what’s best for your financial situation.
Should your emergency fund be invested?
Ultimately it becomes a personal decision and one you need to make based on your situation. Investing sounds like a great idea because it could help your emergency fund grow larger, but it also has the risk of losing value.
Ideally you should at have at least some money in cash (you decide how much) as you don’t want to run up high-interest credit card bills or need to sell stock to pay your bills.
One piece of advice I heard years ago was to avoid investing money in the stock market you may need within the next 5 years.
The theory is that you may need at least 5 years to recover any losses if the stock market goes into difficult times. It’s a hard choice because in good years you’ll see a better increase in the value of the account compared to a high-yield savings account. But in the bad years, you’ll be thrilled that your money is safe.
Personally I decided to keep to the 5 year advice and have my emergency fund in a high yield savings account, just in case.
Choosing a bank account for your 6 month emergency fund
Your emergency fund should be kept in a bank account that earns interest, such as a money market account or a high-yield savings account. You could also consider a laddering CDs so that you’ll have access to at least 1 month of expenses at any given time.
For a high yield savings account, shop around to find the best interest rate available. You should also check for an account minimum requirement. Let’s avoid the fees and missing out on earning interest! Usually your local bank has lower interest rates compared to the online high yield savings accounts.
Money market accounts and high yield savings accounts generally limit the number of monthly withdrawals. That’s ok since this account is meant to be used only for emergencies, not paying your bills each month.
In the case of an emergency you could use a credit card to pay the immediate bills to pay off later, or transfer a larger sum of the emergency funds to a checking account to use immediately.
Finally since the Great Recession, the interest rates on the high-yield savings accounts are back on the rise. I’m not sure we’ll see 4 1/2%+ interest rates any time soon, but 2% rates are currently available.
Over to you, did you decide to build a 6 month emergency fund?
A 6 month emergency fund can give you enough breathing room to cover your monthly bills if you find yourself without a regular paycheck for a long time, or have a really large unexpected expense.
Each person needs to decide how many months worth of expenses to save just in case. Starting with $1,000 helps but likely will run out quickly if you miss a paycheck or two.
What went into your emergency fund goal decision?
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