How big should my emergency fund be?

Emergencies will occur.

There is no way around this. What can be controlled is whether one is prepared for them. How to prepare for emergencies is a function of how we define them. Understanding what are true emergencies allows us to determine how big an emergency fund one should have.

First, a definition.

For something to be categorized an “emergency”, it must truly be something that is unexpected. Emergencies are things that are possible but not certain. A slip and fall that sprains an ankle is possible but not certain. Therefore, it would be considered an emergency since it reduces your income due to missed work.

Flat tire? Not an emergency.

The likelihood that a tire will go flat as a result of having been driven until it is bald is also possible and given enough time, certain. That would not be an emergency.

In the case of a bald tire that needs to be replaced, most would classify that as an emergency only if they don’t have the funds necessary to replace the tire. To properly be prepared for this scenario, one must start with recognizing the tire will need to replaced at some point due to wear and tear. Budgeting and setting aside money for car maintenance would be a proper way to prepare for this. It is certain to happen so set aside money to use when the time to replace the tires occurs. A fund for such a purpose would be outside of what should be in an emergency fund as this isn’t an emergency.

Be prepared.

Although difficult to predict how and when an emergency might occur, understanding that at some point it will happen allows us to plan for the inevitable. One way to do this is to have proper insurance that is for the correct amount. Another is to have a fund in place that can be used to offset the negative effects associated with a true emergency.

Here’s the Bottom Line

How much should be in this fund is a function of one’s job stability and monthly expenses. One who is well established in their job might consider having three months of expenses in an emergency fund. Those with a less stable job might consider having six months set aside. One who has a sense that trouble may be brewing might consider increasing their emergency fund above these recommendations but should never go below the three month threshold. Once they understand how far into the future they should be prepared, they simply multiply their monthly expenses by the number of months to get the recommended size of their emergency fund.

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