This question seems to always come up when it comes to the emergency savings. Unfortunately, there is no quick answer to this. My answer is typically: it depends (gee, thanks Bryan). My general answer is 3-6 months of living expenses. If you don’t know your monthly expenses, this would be a great first step up a budget to finding this answer.
Once the length, in months, is set, you can apply your monthly expenses to get your emergency savings goal.
Emergency Savings Amount = Expenses per Month X Number of Months
Here are a few factors that need to be addressed to find the emergency fund target that’s right for you.
Your Income.
Shannon italia, head of Career Services at the University of North Florida, told me that the average length of a job search depends on the salary you are looking for. She believes that you can expect an average of 1 month search for every $10,000 in yearly salary. According to this equation, if you are looking for jobs in the $30-$40k range, you can expect an average job search of 3-4 months. If you are in the $80-$120k range, it may be 8-12 months before you find the right fit.
That being said, you will want to tailor your emergency fund around the above equation. Those making a higher yearly salary will want to lengthen their emergency savings accordingly.
Your Empoyer/Industry
Your employer and industry may play a part in the length of your emergency fund. These are not hard and fast rules, but generally, the smaller the company, the more susceptible to layoffs you may be. Is your employer making good profits quarter after quarter, or are they struggling to keep the lights on? These answers may not be completely evident, but most employees can see clues when their company is struggling financially. These are clues to perhaps lengthen your emergency fund.
Is the industry you work in a boom and bust industry? If I were a doctor or a nurse, I would be shaking my head no. If I were a mortgage broker or a real estate agent, I would be shaking my head yes. This question also plays a role in how long your emergency fund should be.
Not sure how to answer this question? Ask yourself how deeply your industry has been affected by the recent economic downturn. I can say that for me, the financial/banking industry has been significantly impacted by the recent recession; therefore, we need to plan our emergency fund accordingly.
Your Risk Tolerance
Your tolerance of risk should affect your length of emergency savings. I know people who lost a lot of sleep in 2008 due to the economic turmoil and some people who were oblivious to it. Both sets of people had money invested in the then tanking stock market, but reacted completely differently. If you fall on the low end of the risk spectrum, you will want to add length to your emergency fund.
Your risk tolerance, or lack thereof, is nothing to feel bad about. It is simply something that needs to be addressed. For married couples, this is an especially important issue to be addressed. For instance, I would be a 7 out of 10 on a risk tolerance scale (1 being the lowest, 10 being the highest.) Dana would also be a 7. I try to account for the average of the two of us when making decisions based on risk tolerance.
Please remember to account for your spouse. For a long time, our decisions were based on my risk tolerance. Why? I was making the financial decisions alone and not including my spouse. I didn’t have ill intentions, I was just flying solo with our financial decisions. Talking to your spouse about these decisions will add a whole new dimension to your relationship as well as your finances.
You can use the attached Excel spreadsheet to determine your emergency savings goals.
Click on the link to open Emergency Fund Calculator
What Is your/will Your Emergency Fund Savings Target Be?
