Emergency Fund

Anytime you check in on a personal finance podcast or YouTube video, it seems like this is mentioned multiple times. But how much of an emergency fund is truly sufficient? Why do you need an emergency fund? So many questions about a simple bank account. 

The truth is, I think an emergency fund depends on the household dynamic. Is it a two-income household with children? Single income with children? No children? Single person? Retiree? This is why I do not think an emergency fund with “x” amount of dollars for “y” number of months is a one size fits all solution.

First, we need to discuss what an emergency fund is and what it is not. What an emergency fund is NOT is a fund that you draw money from each month. The point of an emergency fund is in the name; it is a fund for emergencies. It is the money that is stuffed under the mattress. The money in the safe. The money in the bank account that no one touches. This money covers emergencies that your budget cannot cover. A flat tire. The furnace or air conditioner goes out when the elements are unlivable. The deductible on your home for a new roof. Expenses like that.

So how much should someone have in an emergency fund? First off, it depends on where you are in life. Are you in “let’s pay off this debt as soon possible” mode? If so, there are a couple different opinions on how much to have. Dave Ramsey would tell you $1,000. I personally cannot think of many emergencies where $1,000 would suffice. Maybe a flat tire as long as it is just a flat tire and nothing more.

Some people say 1 months’ worth of expenses. But that would not really be an emergency fund at this stage in the game. That is an emergency fund post-debt payoff. 

The Money Guys on YouTube say this fund, during debt payoff mode, should be equal to your highest insurance deductible. Personally, I also like this idea. Because some of the biggest emergencies you will run into are for your house, your car, or your health. All of which have deductibles as long as you are insured. So - find your largest deductible and have your emergency fund be equal to that and DO NOT TOUCH that money until you are out of “pay off debt” mode.

Another great thing to do with your emergency fund is put it into a high yield savings account. A HYSA can get 3-3.5% interest on your money. If you do not plan to touch this money, you may as well park it in a great vessel to gain additional interest off of it.

After you have paid off your necessary debt and you have achieved a comfortable hold of your budget and financial situation, now is the time to set your household up with a 3–6-month emergency fund. This emergency fund is the same in the way that you should NOT TOUCH this money, but the amount will differ. This is a 3–6-month emergency fund, so it should be able to keep your family afloat for 3-6 months if something drastic were to happen (injury, death, lose your job, etc.). Now, how much of your expenses should it cover and do you need 3 or 6 months?

In terms of the amount per month that should be saved, it needs to be your total expenses for the month. Not just your fixed expenses, like your house payment and bills and subscriptions, but also your variable expense predictions should be covered too. If you spend an additional $1,000 a month after your fixed expenses for groceries, gas, etc., then your emergency fund per month needs to be the fixed expense amount + $1,000.

Now, should the fund be 3 or 6 months' worth? Well, this is based on someone’s risk tolerance, their insurance portfolio, as well as age of the person. 

First off is your insurance portfolio. If your household has a strong insurance portfolio that can replace income if an injury were to happen (life insurance for death settlement. Disability, long and short, if an injury were to happen and you cannot work) then you are covered sufficiently in terms of income replacement for that aspect. Check out my blog post about setting up a good insurance portfolio to help reach that financial peace of mind.

Next is someone’s age. If you are 30 years old and have a couple young kids, I would strongly urge you to get that emergency fund for 6 months. Mainly because it is not just you that you are providing for, but it is also your family. If the person is 50 years old or older, I would first look at your retirement amount to see how much of an emergency fund to have. If that person is behind in retirement, then a 3-month emergency fund will suffice, because any additional income needs to be invested into your retirement account so you can retire at a good age. Conversely, if you are 50+ and have a strong retirement position, save up for 6 months' worth of emergency funds and then invest the rest. Lastly, if you are a single person who is of any age, I would think your expenses are going to be lower than someone who is married with or without children. In this situation I would recommend saving up for a 6-month emergency fund, because if something happened and you lost your ability to make money, there is no one else to count on.

Lastly, risk tolerance. If you are someone that feels you can go out and get a job the same day you get fired, then bet on yourself and save for less months and invest more. If you are the latter and feel as if the job market is not great or do not want to take that risk, then keep more money in savings. When it comes to risk tolerance, I think it comes down to the liquidity of your money. Liquidity is how quickly money can be spent or turned into cash. Money in a checking or savings account is liquid because it is cash and cash can be spent immediately. But money in an IRA or 401k is not as liquid because first it has to be withdrawn and on top of that there will be fees. 

When it comes to money, I personally would like to err on the side of caution and not be very risky, but I cannot force anyone to do anything. You can lead a horse to water but cannot force it to drink.

I know those paragraphs may not answer the question very well, but I feel like those are the key factors in deciding what your risk tolerance is. One more additional factor is the household dynamic. If the two adults in the household work full-time, more than likely there does not need to be a large emergency fund; 3 months is more than fine. If it is a single income household and someone stays home with the kids, then yes, an emergency fund is VERY important and needs to be 6 months because if something happens and that person cannot work, life gets tough and tight really quick! 

Personally, my household is very risk averse. I do believe that if I were fired today, I would be going to every fast-food place in town and have a job by the end of the week. It is just the person I am. My wife has great recession-proof employment. We also have a strong insurance portfolio with good life insurance and disability insurance setup. 

My wife and I both work, but we are also saving money because we want to start a family here soon. Then once she does have our child, since we have been diligent with our money, she plans to stay home with the kid(s). With that information, you can assume that we have a 6-month emergency fund… Actually, we have more than 6 months because we value liquid money more because we plan to be a one income household here in the future.

When debt is paid off and saving for an emergency is handled, the excess money needs to be handled somehow. What a great problem to have! The best way to handle those additional funds is investing them in an investment vehicle that will grow with interest. A high yield savings account will get maybe 3%, but the stock market will get your 7-10% based on past performances. Since the emergency fund is satisfied, now is the time to determine what your risk tolerance is. Is it investing into an illiquid retirement account that maximizes returns, utilizing a lower return HYSA, or meeting in the middle by investing in CDs? That is for you and your financial situation to decide.

I am not a licensed investment manager, so I cannot tell you where or what to invest in. The best way to make that decision is reaching out to a trusted financial advisor or utilizing other education tools (such as the Internet and all its fine information) to make those decisions. I am sure you will figure it out. 

God Bless

Bubba Miller