Episode #28: How Much Should You Save In Your Emergency Fund?
Today’s lesson to help you adult like a pro and manage your finances like a boss is all about emergency funds, more specifically how much money you should have saved in your emergency fund. If you’ve been around here for a while, you’ll know that this is one of our specialties at the How To Adult School!
Having a fully funded emergency fund) (not just a few dollars in one ‘cuz you kinda sorta started one but then raided it for a vacation and forgot to keep working on it) is the first step you should be taking if you want to get in control of managing your finances. Having a full funded emergency account will give you so much peace of mind, you’ll sleep better, your stress about money will start to disappear, and you’ll suddenly find that you’re able to make better and more logical financial decisions without all this fear of ‘what if I don’t have enough’ floating around in the back of your mind and scaring the bejeesus out of you. It’s actually fascinating the mental shift that takes place when you have this cushion and safety net of money, you relax, you start to think more clearly and positively, your ‘I can’ts’ and “I have to’s” about money will switch to ‘I can’s” and ‘I can choose to’s” and this is honestly one of the most valuable things you can ever do for yourself.
The big question though, is how much do you need to have in your emergency savings account to consider it ‘fully funded’.
This is a heavily debated topic in the personal finance world. You’ll find answers ranging from the classic $1,000.00 emergency fund, to the more up to date 3-6 months worth of living expenses fund, to the more extreme ‘millennial whose already been burned multiple times in their working life’ answer of 1 year’s worth of living expenses.
And the truth is, there’s no right on wrong answer, annoying, I know. This is something that you have to decide for yourself, and today I’m going to walk you through some of the factors you need to consider, and then how to calculate how much money YOU need to have in YOUR individual emergency savings fund.
The first thing you need to consider is, what are the possible things that could go wrong in your life, that could derail your income, that you would need time and space to recover from, and how much time would you need to bounce back from this.
A common example of something to plan ahead for would be, losing your job. This is something that can happen to anyone, and everybody should plan ahead to this potentially happening at some point in time. If you’re young and working a fun and free job like serving in a restaurant, working as a barista, chances are you’ll be able to find a new job that pays you a similar amount in a relatively short period of time. So, if this is the case, then maybe you feel safe putting aside 3 months of living expenses, because realistically you’re pretty certain that you can find a comparable job within a few weeks to a few months. Maybe you’re working in a highly sought after industry right now, like tech. You have a higher paying job, but you know there are lots of other high paying jobs in the industry who are looking for candidates right now, so again you’re confident that you can find another comparable job within a few months, and you don’t need a massive emergency fund.
As you progress in life, maybe you’ve found that now you’re a bit older and your career has progressed to see you working in a really niche industry with a really specific skillset. If you lose your job, there are other jobs out there, but they may not pay as well without having worked up the company, or they may not be the best use of your particular skillset, so you need to search and hunt and wait a few more months for the right job to come along again. In this case, maybe you judge that 6 months of living expenses in your emergency account will see you through. Even if you have a 3 month fund from your younger years, you now need to add to it so you can buy yourself more time.
On the other hand, maybe you’re like me, and you feel more comfortable tucking aside a larger amount like 1 years’ worth of living expenses in your emergency fund. Maybe you were burned during the pandemic, and your job in a previously stable industry dried up overnight so now you know you need more to be able to sleep well at night. Maybe like me, you’re a young entrepreneur and you don’t necessarily have the safety nets in place of a traditional job, so you want to build your own with a larger emergency fund.
There are all kinds of lifestyles, and jobs, and living situations that affect how much you ideally want to have tucked away for a rainy day. If you have the option of moving home for a while if things don’t go well then you’ll need less, if you’re worried about the potential of injury in your job then you’ll need more. Think about you and your individual situation, and decide what feels best to you, keeping in mind that you can always add to it later, and actually should periodically review it an adjust for things like increasing costs of living, every few years.
So, once you’ve decided how much time you want to buy yourself with your fund, whether that’s 3 months, 6 months, a year, now you need to know what your monthly living expenses are.
How To Calculate Your Monthly Expenses For Your Emergency Fund
When we talk about saving for an emergency fund, you want to be considering your basic living expenses. This means expenses that you have to continue paying regardless of whether or not you’re currently working. This typically includes things like rent or mortgage payments, grocery bills, car insurance, life insurance, internet for some people and other expenses like that. When you’re saving for your emergency fund you shouldn’t be saving extra for vacations, beers with the guys, or Sephora shopping sprees. The idea is if you find yourself in a tight spot, you should be cutting back on most of your frivolous expenses to get your savings to stretch as far as possible. Also it makes it much less daunting to save this lump sum of money when you’re saving for just your needs, not your needs, and wants, and impulse purchases, because suddenly that’s a lot more money to save.
So, to calculate your monthly expenses, start by making a list of all the necessary living expenses you can think of and how much they cost each month. Then take a look at your credit card statements, bank account transfers, and other ways that you spend money, to see if there are any living expenses that you didn’t remember to include in your list yet. For example maybe you see a charge for your cleaning at the dentist from two months ago, and this isn’t on your list yet. For expenses that are necessary but that don’t occur every month, like going to the dentist, just average how much you spend on these things on a monthly basis. If you spend $400.00 on the dentist each year, then that averages out to about $33.00 a month. Next, look back through this list, and see if there’s anything listed here that you would actually stop paying if you needed to. Netflix subscriptions are a great example of this. Take these expense off your list, then add the rest up to find your monthly necessary expenses.
Next, take this number, and multiply it by the number of months you want to have saved in your emergency account. If you’re anything like me, this number is going to seem really large and really daunting at first. Chances are up until this point you’ve been largely focused on paying expenses one month at a time, and now suddenly you’re asking yourself to save up a lot of money, and that’s okay. Saving for your emergency fund doesn’t always happen quickly. It took me a long time to save my year’s worth of expenses, and I kept topping it up after that as my living expenses increased over time. It’ll take a while, but it’s a really worthwhile goal, and you’ll be surprised by how much you want to start saving rather than spending your extra dollars with this carrot of emotional freedom and financial well being dangling in front of you.
If you’re struggling to come up with ways to save this money right now I’ve created a separate episode all about this called 10 Ways To Save Money Quickly For Your Emergency Fund. I definitely recommend checking out this episode next because it’ll walk you through 10 unexpected ways you can make some temporary changes to your expenses so you can save a bit of extra money and get that emergency fund built up quickly.
Also the easiest way to get this money to save up faster is to keep it in a specific type of online bank account called a high interest savings account, also known as a HISA. This is an account usually offered by online banks that gives you a better interest rate than what you’re currently earning at your bank. Chances are your accounts are probably making around 0.01% interest right now, and you can earn over 100x more interest with a basic high interest savings account, that today has somewhere between a 1-1.5% interest account. I have my emergency fund in a high interest account that’s currently earning me around $70.00 in interest a month, which adds up, and every bit helps, especially when you’re trying to save this account balance up as quickly as possible.
If you want to open up a high interest account to get started on your emergency fund, the top interest rates are always changing with a neck and neck race between some banks, so I keep an updated page for you with the best Canadian high interest savings accounts currently on the market.
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