Fewer than half of Americans have enough money saved to cover an unexpected expense that costs $1,000, according to a survey conducted by Bankrate. This isn’t too surprising when you consider that almost 60 percent of Americans have less than $1,000 in a savings account, according to a separate survey conducted by GoBankingRates.
Statistics like these point to the importance of building up an emergency savings fund. Also sometimes referred to as a “rainy day” savings fund, this is an account that you can tap if you’re ever faced with a major unexpected expense — like a home or car repair or medical bill — or if you lose your job and are unemployed for a period of time.
Without an emergency savings fund, you might have to use debt to pay for unexpected expenses. Many people end up using credit cards to pay for these kinds of expenses. While it’s easy to just whip out the plastic, doing so can be an expensive strategy because many credits cards feature interest rates of 18 percent or higher.
How Much is Enough?
The first question many people have about building an emergency savings fund is simple: How much money should they save in this fund? One survey found that 38 percent of college-educated adults believe that around $5,000 is the right amount of money to save in an emergency fund.
Meanwhile, a common rule of thumb is to accumulate between three and six months’ worth of living expenses in your emergency fund. But this is a broad range and the term “living expenses” will vary considerably from one person or family to the next. The Certified Financial Planner Board of Standards offers guidance that’s a little more specific:
- Single-earner households should save up at least six months’ worth of living expenses.
- Dual-earner households and single-earner households with a second source of substantial income should save up at least three months’ worth of living expenses.
However, this guidance is still fairly vague. For example, a single individual who rents an apartment instead of carrying a mortgage and keeps his living expenses fairly low probably won’t need as large an account as a married sole breadwinner with a mortgage and three children. Similarly, self-employed individuals and business owners whose income fluctuates from month to month might also need to save more money in their emergency fund.
Crunch Some Numbers
To figure out the right savings target for you and your household, start by creating a budget so you can determine what your monthly expenses are. It should include both fixed and variable expenses. Fixed expenses stay roughly the same every month — for example, things like your mortgage or rent, insurance, car payment(s) and utilities. Variable expenses fluctuate from month to month — they include things like food and groceries, clothing and entertainment.
This will give you a starting point by telling you how much monthly income is needed to maintain your current lifestyle. But keep in mind that if you were faced with a serious financial emergency like a job loss you would probably look for ways to reduce your variable monthly expenses — for example, by eating out less and grocery shopping more frugally.
Next, analyze the likelihood that you might suffer some kind of major financial emergency. For example, how secure are your and your spouse’s jobs (assuming yours is a two-earner household)? Does your health insurance expose you to potentially high out-of-pocket costs due to high deductibles and co-pays? And what is the age of your cars and home? If they are fairly old, you could be at higher risk for major costly repairs.
Based on all of these factors, you should decide what is the right amount of emergency fund savings for you and your household. This may be more or less than the rule-of-thumb guidelines suggested by financial experts — and this is OK, because it’s based on your specific budget and financial circumstances.
Where to Park Your Money
It’s usually a good idea to keep your emergency savings funds parked in a liquid savings or money market account. You probably won’t earn a high return in such an account, but your risk of loss is also very low. And most importantly, you can access funds quickly and easily if you need them.
Look online to find an account paying the highest possible return. For example, some online banks are offering high-yield savings accounts that pay interest rates as high as two percent. Just make sure that you can access your money at any time without penalty. Also note that some online banks place limits on the number of withdrawals that can be made from money market accounts each month.
Give us a call if you have any more questions about how much money you should save in your emergency savings fund.