Emergency Funds – How Much is Enough?

Financial experts and advisers may not agree on much but they all tend to agree on one thing. You need to have an emergency fund. Common advice is to have between three and six months’ worth of expenses in your emergency fund.

The question of the day is how much of an emergency fund is enough it today’s economy? There’s no easy answer. In fact this is one of the areas where the subject of personal finance gets very personal.

There are a lot of people in this country who are long term unemployed. When I say long term I mean they have been unemployed for well over a year. When you’re in that position and your unemployment benefits have, or are about to run out, you need to have an emergency fund left. Most people don’t.

Let’s face it – unemployment benefits don’t cover much. Depending on the state in which you live your benefits would probably be between 35% and 50% of your average weekly wages. Let’s start there to try to work this out.

Here are the things you need to assess:

1. What are your prospects for re-employment at a similar wage to what you were making before you lost your job? This is the primary factor determining how long your emergency fund needs to last. If you work in an industry that’s been decimated by the current economy or by off-shore out-sourcing, your prospects might be slim and your emergency fund will need to last longer than if you are in a high-demand profession.

2. Let’s say your unemployment benefit is 35% of your average wages. If you’re a single income household, your first action must be working out how much you can cut from your spending. If you can achieve a 65% reduction in outgo, you’ll be able to save your emergency fund for the unhappy possibility that you might still be unemployed when your benefits run out. If you’re in a two income household the amount you need to reduce your expenses will depend on how much of your expenses the other income plus your unemployment benefits will cover.

3. If you can’t achieve an adequate reduction in your expenses, that means you’ll need to be able to tap into your emergency fund from the get-go to cover the portion of your reduced budget that your unemployment benefits can’t cover. From there you can figure out how long your emergency fund will last.

Here’s what we know about the current economy. The unemployment rate remains high. There are millions of people who have been out of work for well over a year. Unemployment insurance benefits have run out for many of those people and things still look pretty bleak as far as the job market turning around. Those circumstances present a pretty grim picture.

Here’s another scenario that made me re-think the whole emergency fund concept. It’s something that happened to me personally. Being self employed is a great thing when your business is working and you’re covering your expenses and have disposable income to boot. When technology, regulatory changes, the economy or just a few bad decisions put you in the red, you need to have an emergency fund to get you through the process of fixing the problems you’re having with your business (if they can be fixed). If the problems you’re having can’t be fixed for some reason your emergency fund needs to last long enough for you to “reinvent” yourself and your business if you choose to go that route or to make the transition from business owner back to employee if you choose to go that route. The problem is that its difficult or impossible to predict how long the emergency fund needs to last in those circumstances. Once that emergency fund cushion is gone, you’re going to have problems. Been there. Done that. Even if you want to make a go of your business, if you can’t fix the issues in time you may have to close it down and drastically change your lifestyle anyway.

So the question is, how big an Emergency Fund do you need?

Do you need an emergency fund that can cover eighteen months to two years of income loss? I’d say most people don’t. That’s a pretty extreme set of circumstances.

I’d also say that you need to take a look your profession/industry you work in. Are the prospects for landing on your feet either as an employee or a business owner good? Are there factors out of your control that could prevent you from landing on your feet before your funds run out?

As I said earlier this is where the subject of personal finance becomes very very personal. There is no definitive answer that fits everyone.

Here are my opinions on the matter after talking to several people who’ve been unemployed for a long time.

In today’s economy three months’ worth of expenses is only adequate if your profession or your skills are in such high demand that you’re able to rebound from a loss of income quickly.

Six months’ worth of expenses in your emergency fund might be adequate if you are a two income household and you’re quite good at budgeting your money and feel you can weather the storm for a while. Nine months is probably better. Nine months worth of your current expenses could be stretched to Twelve months or longer once you slash your budget and if you have some replacement income coming in, such as unemployment benefits.

What do you think? How big should your emergency fund be in today’s economy?

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