What Is a Realistic Amount for Emergency Savings?

April 30, 2011

Emergency Savings Tips from Debt Reduction Services IncChances are that if you’ve ever looked into how much money you should be putting away as an emergency/”rainy day” fund, you have found that most financial experts, including myself, will suggest something like three to six months’ worth. The question, though, is three to six months’ worth of what? Gross income? Net income? All household expenses?

Here’s my take on this vital subject. First of all, it is my opinion that having an emergency fund is one of the top two or three indicators as to whether a household will remain financially stable or remain living continually on the edge of a financial abyss.

Next, I differ from many professionals who advocate paying down credit card debts and establishing a retirement fund before ever working on an emergency savings strategy. When asked which of the three should be the priority (emergency fund, credit card debt repayment, or retirement funds), my answer is always the same: “yes.”

From my experience, emergency savings is an attitude that leads to action, so committing to saving regularly, even in small amounts initially, is more important than trying to figure out long-term amounts. Perhaps, an initial savings goals could just be having $1,000 in a savings account within a reasonable time (perhaps 6 months or a year). If you can achieve this, you’ll already be ahead of 85% or more of the general US population.

That said, to establish a truly effective emergency savings strategy, each household needs to look at their current income sources (usually some type of employment) and ask themselves, “If I were to lose my job today, how long would it take for me to find another job earning me/us about the same income?”

A recruiting specialist once shared her rule of thumb with me that I think works in many situations: For every $10,000 of annual income you receive from your current employment, it will likely take you a month to find a replacement position. That means that if you earn $30,000 a year, it will take you on average 3 months to find another similarly paying  job.

However, during an economic downturn, it would be safe perhaps to double that estimate. So $30,000 of annual income might take 6 months to replace.

Next, now that you have an idea of how many months you might be without income, multiply those months by the amount of money you would need not only to survive but also to be at least minimally comfortable.

  1. Include expenses such as rent/mortgage, vehicle-related costs, food, basic clothing, utilities, holiday and birthday gift giving, and any contracted services with penalties for early cancellation.
  2. Do not include expenses related to vacations and travel, dining out, external entertainment (think theater, cinema, clubs, concerts, etc.), back-to-school shopping, charitable giving, etc.

If you ever lose you employment (or if you have a major medical event), your household should go into financial lockdown immediately, cutting out all expenses under List #2 above while planning for those under List #1. Unfortunately, we all tend to be far too optimistic about our ability to find re-employment soon, leading many to continue to spend at current levels even though we no longer have steady income. Of course, even if you do qualify for unemployment income (for which many do not because of the circumstances leading to their job loss), it only replaces a small percentage of your monthly income.

In summary, if you earn $40,000 per year and have monthly expenses (under #1 above) of $1,800, you’ll want approximately $7,200 available to you in case of job loss (4 months x $1,800 = $7,200).

Where to keep your emergency savings?Does that mean that you should put it all in a savings account, earning .25% interest? Of course not. You want to earn as much interest as possible while also keeping the cash in a fairly easily accessible account (“liquid”). One possibility would be to work toward having four 4-month Certificates of Deposit of $1,800 each, with one maturing each month. Money Market accounts may also work as emergency savings vehicles.

Best wishes in developing and implementing your emergency savings strategy. It will take time and effort, but in the end, it will definitely be worth it.

Todd

Todd Christensen
Director of Education
www.NationalFinancialEducationCenter.org
Facebook: MoneyDay2Day
Twitter: Day2DayMoney

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Published in: on April 30, 2011 at 9:42 am  Comments (1)  
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