In my last post on emergency funds, I looked at Dave Ramsey’s (and many others’) suggestion of an emergency fund size of three to six months of expenses and calculated what that would be for our current budget ($7,500 to $15,000). But at the end of the post I questioned whether a three to six month emergency fund is really appropriate for us. I am an overthinker, so I have trouble just accepting that we need three to six months of expenses put aside to do nothing but contend with potential emergencies.
Do you know how many times we’ve accessed emergency money in the last six years? Zero. We’ve used our savings plenty of times, but (and I know I’m inviting Murphy here) we have yet to have an emergency. We’ve had to repair our cars several times, but that sort of expense isn’t unanticipated. Even when we have had deaths in the family we were able to cover our travel out of our Travel targeted savings account or our plane tickets were given to us by another family member. We have never had to pay for non-routine medical expenses, and if we did we have a bit of money set aside for that purpose.
What Is An Emergency Fund For?
I reviewed many articles and blog posts on determining emergency fund size, which I will link to as part of this post. There are generally two categories of expenses people want an emergency fund to provide for: job loss and broken things. In my observation, calculations of EF size use one or the other approach but usually not both.
Wealth Informatics calculates a personalized emergency fund size accounting for both job loss and broken things. This post is modeled after her approach so I highly recommend you check it out.
By far the most popular reason for having an EF is to cover basic expenses in the case of job loss. That’s why the standard advice for how large an EF should be went from “three to six months” pre-recession to “six to nine months” during the recession. People believe that in the “new economy,” jobs are not very secure and finding another one will take significant time. Expenses instead of income are used as a nod to the hope that you’re living under your means before the job loss, but there is not much discussion of how a married couple or people with multiple income streams should adapt the advice – there is inherently more income stability when it is coming from diverse sources.
Free From Broke compiles a list of questions you need to ask yourself when you evaluate how much of an EF you might need in the case of job loss.
The Money Principle points to three life scenarios in which an emergency fund is even more vital.
The situations that most people probably think of when they hear the word “emergency” are unexpected medical problem, car troubles, or housing repairs. Basically anything that is a large asset (including yourself) may need money spent on it to become functional, and there are a few things that you really need to be functional. Having to travel unexpectedly for a family emergency may be another “broken thing” to consider for your EF.
What Should My/Your Emergency Fund Cover?
While “three to six months of expenses” isn’t a bad place to start, the generic advice may leave you with an underfunded EF (and up a creek if you ever actually need it) or the opportunity cost associated with having too much money sitting in cash. (This opportunity cost is why many will advocate keeping a smaller EF while paying of non-mortgage debt.) In the remainder of the post I’ll show you how I’m calculating my personalized emergency fund; you can do a similar exercise for your situation.
Budgeting in the Fun Stuff suggests several questions that will help you determine your EF size.
Edward Antrobus argues that $1,000 isn’t enough of an EF even while paying debt.
Job Loss vs. Broken Things
I think it’s reasonable to consider either the job loss approach or the broken things approach to calculating an emergency fund size and go with the larger.
Kyle and I are not at all fearful of job loss or unemployment. I realize that is uncommon – it’s directly related to our positions as grad students. You have to consider how diversified your income sources are, the security of your current position, the unemployment rate of your particular field, and the job opportunities in your local area. If you’re self-employed or have a variable income you’ll want even more savings in place, whether it’s for smoothing out your income or to keep you afloat when you aren’t bringing any money in.
Diversified Finances emphasizes that people with different life situations will have different sizes of emergency funds – self-employed individuals, homeowners, people in debt, etc.
Given that we weathered the Great Recession in our respective advisors’ labs, it’s unlikely that we will find ourselves without a job unless we have graduated. Even in that case, it’s fairly routine for a new PhD to stay in her same lab until she finds a postdoc (this will be what Kyle does next semester). I actually think it’s more likely that one of us would become ill and have to take a leave of absence than to be kicked out of our lab. And for both of us to lose our positions at the same time, I think our university would have to become inoperable or the government to stay shut down forever.
Even if one of us does lose our position or funding, I have worked out an emergency budget in the case of only one of us pulling an income and with it we are only about $100/month in the red. It’s likely that we could make up that difference in desperate-times side hustle income (if we are both healthy) each month so we wouldn’t even have to dip into savings.
Basically, our secure positions plus that there are two of us making the same income plus our relatively low monthly nut means that our present situation makes the need for a job-loss-related EF quite low.
The Frugal Toad lists sources of income in an emergency beyond the emergency fund.
On the other side of the equation, we do have things like our bodies and car that we would like to keep in working order should they decide to malfunction, so I think our EF should be based on preparing for the possibility of broken things.
Things You Own that Could Break
Try to think of all the things you would need to replace or repair swiftly if they broke. Is that a long list or a short list? How many of those items do you have insurance or sinking funds for?
Get Rich Slowly outlines several characteristics that eliminate your need for (part or all of your) EF.
Homeowners are definitely going to have the longest list. If some kind of disaster struck your house, I would hope you have the proper insurance in place. As far as repairs go, do you have a savings account for repairs or would that be considered an emergency? Because we are renters with renter’s insurance, I’m largely unconcerned about stuff breaking in our home. Anything we really need, like major appliances, would be repaired by the management company. We don’t personally own anything super expensive that would constitute an emergency if it broke. Our renter’s insurance deductible is $500 – just in case our house burns down or everything is stolen or something.
How about your car(s)? What kind of insurance do you have on those? Are car repairs covered by a savings account or are they emergencies? We have comprehensive and collision insurance on the car we drive, and we could always switch to driving our other one if it is rendered inoperable (after re-insuring and re-registering). Our car insurance deductible is $500 and we have a savings account dedicated for car-related expenses, including repairs.
People in your family are the last major breakable thing. Insurance should take the brunt of these expenses after deductibles are met if your body breaks – health insurance, disability insurance, etc. You should also consider how you would travel to your family members should they need you and perhaps add that possible cost to your EF. We only have health insurance, but we have no dependents. Our health insurance (for each of us individually) has a $500 deductible and a $2,500 out-of-pocket maximum for coinsurance.
The Simple Dollar recommends adding a month of expenses to your EF for each dependent you support and 2% of your home’s value.
What’s a Reasonable Emergency?
Perhaps some of you think it is better to plan for the worst conceivable scenario, no matter how unlikely, but that’s not our personalities. I think a reasonable emergency scenario would be that one of us will fall ill and have to take a leave of absence from work (as far as I know we do not have access to any kind of disability coverage). This happened to a friend of ours a couple years ago. In addition to having only one income, perhaps we would max out our out-of-pocket pay for our insurance, $3000. We would need $600 to sustain us for a 6-month leave of absence. So that’s $3,600. We have our car insurance deductible covered by our Cars targeted savings account, but let’s say there was some accident at the house and we needed our renter’s deductible as well, $500. That’s a lot of terrible things happening at once!
It looks like a reasonable EF size for us would be about $4,000, assuming we still have our current targeted savings accounts in place. Obviously if both of us were unable to work and racking up health care costs we would be SOL no matter what size our EF was and we would just run through all our available assets!
Narrow Bridge Finance thinks that you shouldn’t keep more than $5,000 in a traditional EF.
General Savings and Tiered EFs
This post isn’t about where to keep emergency money, so I’ll just keep these comments brief. One of the reasons I’m comfortable with calculating a smaller EF is that we have a bunch of cash available in our targeted savings accounts and general savings that could be reassigned in the case of a big emergency. I don’t consider this true emergency savings because we are open to using it for other things. But I think it’s smart to have different levels of emergency funds available – some in cash, some in less accessible investments (we could eventually go into our student loan payoff money if needed), and even some credit if you’re comfortable with that.
Is your EF calculated for job loss or broken things or both? Do you care for/own a lot of potentially breakable things? How secure is your job/industry? Are you planning for a moderate-likelihood emergency or the worst case you can conceive of?
photo from Free Digital Photos