By Megan Doyle | American Express Credit Intel Freelance Contributor
6 Min Read | May 11, 2020 in Money
An emergency fund is a surefire way to help manage unexpected expenses.
Exactly how much you should have in your emergency fund depends on your present—and hypothetical future—financial needs.
It’s okay to start slow and steady, but ultimately it’s a good idea to set aside three to six months’ worth of expenses.
Someone once said, “Life is like a box of chocolates.” Except I’d argue that chocolate is a lot more pleasant than some of the monkey wrenches life can throw at us. While unexpected expenses are a reality of life, they don’t always have to be burdensome or stressful. An emergency fund can make life a lot easier to manage when facing a furlough or a fridge on the fritz.
Yet only about 41% of American adults would cover the cost of a $1,000 car repair or emergency room visit using savings, according to a January 2020 survey.1 And another study found that 65% of American families lack a cash buffer large enough to manage a simultaneous spike in expenses and dip in income.2
An emergency fund can help us weather such unexpected financial storms. But how much should you have in your emergency fund, and where should you keep it?
An emergency fund is money set aside in an easily accessible savings account to help you more comfortably manage major unexpected expenses. This means unlikely extenuating circumstances and financial emergencies—a job loss, an injury, a broken furnace—not a new bike, a vacation, or routine bills. Ideally, you never want to need your emergency fund.
But if you never want to use it, why have it? If you face a major unanticipated expense or an unpredictable shift in your income without the cushion of an emergency fund, you’ll likely have to cover costs with a credit card or even take out a loan. This means you’ll be in debt, and may have to pay more than the cost to overcome the emergency due to interest charges.
How much you should have in your emergency fund needs to match your fixed—and hypothetical—financial needs. To get started, calculate your total core monthly expenses. This usually includes:
Note that the list of core expenses does not include things like entertainment, shopping sprees, or dining out. That’s because they’re “discretionary” expenses—the things that are likely to be cut first when tightening your budget.”
Now, let’s say your core expenses add up to $2,000 a month. To really zero in on how much you should have in your emergency fund, there are a few ways experts suggest you can think about it:
The three to six months rule: The commonly suggested rule of thumb is to set aside at least three to six months’ worth of your core living expenses.3,4,5 With $2,000 of core monthly expenses, this means you should aim to tuck away between $6,000 and $12,000.
The six weeks of take home pay rule: One report found another way of looking at how much you should have in your emergency fund: at least six weeks’ worth of take home pay.6 On the surface, this sounds a bit different from the three to six months rule. But depending on your income and expenses, it may be just another way of looking at the same thing. For example: if you take home $1,000 a week, that’s equal to $6,000—or three months’ worth of your core expenses (assuming you have $2,000 in monthly expenses).
The deductible rule: Another way to decide how much to have in your emergency fund is to make sure you can cover the deductible on your car insurance, homeowner’s insurance, or health care insurance. That way if your car is rear-ended, a storm damages your roof, or you get an unexpected injury, you can cover your deductible without having to scramble or take on debt.
Whichever guidelines help you decide how much you should have in your emergency fund, be sure to carefully consider your particular financial situation. A recent college graduate who’s renting an apartment and has minimal expenses probably doesn’t need as much in their emergency fund. But there are a lot more potential unexpected costs if you have three kids, two cars, a spouse, and a mortgage.
Ultimately, it doesn’t really matter how you choose to conceptualize how much you should have in your emergency fund—as long as you have one.
If building up anywhere between six weeks or six months of savings seems like a lot, it’s okay to consider the range as a rough guideline. The most important thing is to start saving if you haven’t already. Aim to start with at least $500 to $1,000 in your emergency fund. That way you can cover a small unexpected expense like a damaged cell phone or a car repair. Then, start saving little by little. Even $20 a week can add up over time.
But do the math: if you’re saving only $20 a week, it’ll take almost six years to save $6,000. While slow and steady is a great start, you’ll need ways to boost momentum if you want to build your emergency fund fast. To kick your emergency savings into gear, consider:
An emergency fund needs to be easily accessible. One of the best places to keep your emergency fund is in a high-yield savings account. They’re easy to open, accessible, and generally offer better interest rates than you would get with a traditional bank account—and way more than stashing your emergency fund in a piggy bank or a shoebox.
Try not to rely on a 401(k) or traditional IRA for your emergency fund. While you can access your contributions before you turn 59½ years old, you’ll usually have to pay a 10% penalty and income tax on the money you withdraw. You can, however, withdraw contributions from a Roth IRA tax-free and penalty-free.
If one day it starts raining—and it doesn’t quit for four months—an emergency fund can help keep your days a little bit brighter and a little less burdensome than they would be otherwise. Even if stockpiling several months’ worth of expenses seems like a lot, remember that a little every week can add up over time, too.
2 “Weathering Volatility 2.0,” JPMorgan Chase & Co.
3 “Saving for an emergency,” Wells Fargo
4 “A Quick Guide to Your Emergency Fund,” Dave Ramsey
5 “What's the right emergency fund amount?,” Vanguard
6 “Weathering Volatility 2.0,” JPMorgan Chase & Co.