This is probably one of the questions that I get asked most often. To make sure we’re all on the same page, an emergency fund is:
Money, usually kept in a savings account, for use in the event of an emergency.
Emergencies could have a wide range of causes, such as finding out that a family of squirrels has stashed the corn that you were using to feed deer in your car, wrecking your A/C. No seriously, that happened to a friend of mine!
How Much Cash Should I Keep?
In Building Wealth and Being Happy, I kind of glanced over the topic of emergency funds. That’s because it’s an issue that really puts the personal in personal finance. I don’t know you or what your emergencies could be. But I’ve done some more thinking and came up with an (imperfect) framework to help set the size of your e-fund. Try this on for size!
Add Cash In Multiples Of Your Monthly Expenses:
- Vehicles: Add one month’s worth of expenses for each vehicle or other expensive asset (like a boat) that you own
- Housing: If you own a home, add one month’s worth of expenses*
- OR if you own a home and have a mortgage, add two months’ worth of expenses
- Dependents: Add a month’s worth of expenses for each kid or other dependent you provide for
- Job stability:
- Highly stable – 0 month’s worth of expenses
- Moderately stable – 1 month’s worth of expenses
- Unstable – 2-3 months’ worth of expenses
- Personal risk tolerance:
- High risk tolerance – 0 month’s worth of expenses
- Medium risk tolerance – 1 month’s worth of expenses
- Low risk tolerance – 2 months’ worth of expenses
- Medical: Add the amount of your health insurance plan’s deductible**
- Add more as needed: e.g. significant student debt or long-term apartment lease that’s hard to get out of
*Consider having a minimum of 3 months’ worth of expenses if you own a home
**Consider looking into using a Health Savings Account as well
For example, if your family owns a car and a house, has 2 kids, and you have a moderately stable career and low risk tolerance, this framework would tell you to have at least 7 month’s worth of expenses in cash. Not bad.
Are you really lazy and want that information in an easily shareable and digestible image? Boom.
Did you want that in colour? I’m an accountant, not a graphic designer, but here you go.
Or are you so incredibly lazy that you wanted me to tweet the image so all you have to do is re-tweet it? Okay.
— Graeme Falco (@graemecpa) January 25, 2017
Do I really need an emergency fund?
Many people who are on their way to financial independence choose to forgo a traditional emergency fund. The benefit is that their money earns a higher return instead of collecting dust in a savings account. These investors plan to use a line of credit, or even credit cards to pay for emergencies. If they have to use credit, they’ll pay it off right away – it just takes a couple of days to sell some stocks or bond funds and transfer cash back to their checking account.
I think that’s a reasonable approach for those who are financially secure. At what point should you pare down your emergency fund or even get rid of it? That’s a personal question – I can’t tell you the answer. Most investors I’ve heard from have decreased their emergency funds once they reached $100K in investments. Others are reluctant to get rid of their emergency fund because the security and good night’s sleep it provides them is so important, and that’s okay too.
Where should I put my emergency fund?
Any high-interest savings account is great. I know a lot of Americans recommend Ally Bank.
In Canada, PC bank and Tangerine are the most recommended for low-fee banking. Right now, Tangerine is offering promotional rates of 3.25% for some customers, which is the highest I’ve seen. If you end up joining Tangerine and want to give us both $50, use my Orange Key: 43910445S1
Do you use an emergency fund? How many month’s worth of expenses do you keep in it?