How Big an Emergency Fund Do You Need?

I waded through a wide variety of personal finance literature before writing All The Money In The World. One universal bit of advice was that a prudent household needed an emergency fund. With good reason. Your monthly income may cover your monthly expenses, but what if something goes wrong? Really wrong, like you lose your job or you have to take unpaid disability leave? The idea behind an emergency fund is that you would have the cash in a liquid account to cover those rainy months.

The more controversial question is how many months your emergency fund (or non-retirement savings in general) should cover.

Different gurus have different ideas, because these gurus are also generally addressing the question of how aggressively people should try to get out of debt. Should you build up an emergency fund before paying off your credit cards? If you’re paying 15% on a credit card, and would only get 1% on a bank account, this seems like a pretty easy call. And so Dave Ramsey suggests that people build up a $1000 emergency fund (so they won’t have to rely on loans for a small-ish emergency) and then focus on paying off debt. Suze Orman, on the other hand, has recently started saying that people should build up an 8-month emergency fund before paying off credit cards, since banks are restricting access to capital, and in a pinch, you might not be able to put emergency expenses on a credit card that you’ll pay off later. I learned about this controversy, by the way, by reading the Man v. Debt blog. Other people have other ideas (3 months, for instance, if you have a very secure job and aren’t the only person earning an income).

This whole argument reminds me of why I probably don’t have a future career as a personal finance guru. To my mind, sure, 3-6 months sounds good. 8 months is even better. What’s better than 8 months? 12 months. 18 months. How about two years? The point of having accessible savings is to buy you freedom, and more freedom is better than less freedom. Having two years of your family’s living expenses saved up is the ticket to being choosy in your career, to being able to quit a job if you want, to starting a business without stress. Trying to talk down the amount of months one should have stashed away misses the point. Saying you can build up a 3 month fund and then go back to break-even is like a dieter restricting calories until she gets to her goal weight and then eating like she did before. A better idea is to change your eating habits entirely to be something sustainable and healthy you can deal with your whole life.

Likewise, I think one’s savings should be growing every month, because you are constantly living on less than you bring in. You wouldn’t stop at 3 months, or 6 months. Sure, you’re saving up for retirement too. But if you’re saving 15% for that, then save 10% more for added wealth and security in the near term. If that’s impossible with a current level of spending, figure out how to make more money. And ultimately, make savings like paying taxes. It’s just what happens when money comes in. When people argue about how many months of expenses to save, it’s because they don’t really want to save. And that’s a different problem entirely.

8 thoughts on “How Big an Emergency Fund Do You Need?

  1. I always thought of the emergency fund as just the beginning of savings. That’s what goes in the money market. Of course you keep saving but that goes in the investment pool following the asset allocation of stock and bond mutual funds that we’ve determined works for our long term goals. Our emergency fund is about six months of expenses but we continue to live well below our means and invest the surplus.

  2. To expand on the previous comment… more money in the emergency fund is hurting you after some limit, because a more liquid account like a money market earns less interest. The argument isn’t how many months’ worth of expenses to save, it’s how many months’ worth to keep very liquid.

    1. @Allison and Joy- I agree that having huge amounts in liquid accounts is inefficient (because yes, it’s not earning enough interest… not that anything is these days!) But my impression from reading a lot of these books, blogs, etc. is that this not what the argument is over. People aren’t focused on building up assets in anything except retirement accounts (and even those tend to get underfunded). Man v. Debt mentioned in the blog post that even 1 month would be an improvement for most people. So I don’t think this is about asset allocation.

    2. I concur. We previously invested money in the Washington GET program (covers cost of tuition at most expensive Washington school when beneficiary attends college or trade school, a type of 529) but this money isn’t accessible until our kids are ready for college in 15-20 years. Given a state guarantee that our money will grow at the rate of tuition growth, I liked diversifying out of the stock market but it is NOT a place for one’s emergency fund.

      1. @Twin Mom- wow, there is a state guarantee that it will grow at the rate of tuition growth? So washington state taxpayers are on the hook if it doesn’t? Just sounds like something that could go quite wrong – the stock market has been flat for pretty close to 15 years now. Hopefully that means it won’t in the next 15 but tuition definitely has not stayed flat. Of course, I guess if we’re talking about a public Washington university, then the state is also sort of setting tuition, so maybe they can assure this all comes out.

        1. Washington state taxpayers are on the hook, which is why the cost of future credits has grown precipitously in the past few years. Washington has also raised tuition dramatically so “early adopters” will benefit. One legislator described it as a bit of a poison pill, because if Washington raises tuition significantly, they also have to pay out more as part of the GET program. Of course, this only affects the minority of parents who are in the position to save for their children’s education when they are small, the middle class.

  3. I agree with Allison and Joy’s comments above. You wrote your book starting from the assumption that your readers already know stuff like “don’t rack up lots of credit card debt,” but you mention that the sources you looked at on emergency funds are also talking about how to dig yourself out of debt. Like Allison and Joy, when we look at our finances, we try to assess how much we need to be liquid for our emergency fund and any upcoming expenses versus how much we should invest.

  4. First off to Twin Mom – As a fellow Washington resident and someone who has considered the GET program, it’s a little scary. Since Washington just deregulated college tuition’s this year, each state school is now able to set their own tuition rates. I don’t quite see how the GET accounts will be able to keep pace with those hikes.

    But, back to the subject at hand, this is a great question to raise Laura. Every PF guru will have their own equation but I completely agree that the larger the emergency fund the greater freedom one has in their life. A 3 month fund seems based on the fact that should you lose your job you would need that time to find a new one. However we all know people who have been out of work for 12+ months. Those emergency funds ran out a long time ago. Also, what about those who are self employed or looking to start a business?

    My thought is that 3-6 months in liquid savings and then additional savings in long term investments that could be accessed if absolutely necessary is the way to go.

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