Last fall, our hot water heater malfunctioned and could no longer be repaired. But because we had an emergency fund — sometimes called a freedom fund — we were able to replace the appliance without having to borrow the money. But just how much should a person have in an emergency fund?
Dave Ramsey recommends a fully-funded emergency fund (Baby Step 3) should be 3-6 months of a family’s household expenses. But the answer to this question may also depend on a few other factors. Here are a few more questions to consider…
What are your monthly household expenses?
Many expenses (like your cable bill) are the same each month, but other expenses can be more challenging to predict until you’ve been budgeting for many months. For instance, my gas bill can be about $100 a month in the dead of winter but may be less than $20 in the summer. But after doing your monthly budgets for almost 10 years, we have a solid idea of our typical monthly expenses.
How stable is your income source?
Income stability has two strands.
The first consideration is whether your paycheck varies or is the same each pay period. Like monthly household expenses, a fluctuating income source can be challenging to predict. But again, the longer you budget, the better you’ll get at handling this. But always err on the side of conservatism.
The second consideration is with security of your job or career. Some career fields are typically more stable than others. But in these times, not much is certain. In any event, someone on a stable career path may be good with 3 months. If you feel your career path is less certain, you will want to be closer to 6 months expenses. If your company is amidst layoffs, you may need 12 months.
How big is your “security gland?”
Of course, the ultimate source of security if being debt-free. Owning everything you have greatly reduces stress levels at work, play, and rest. The feeling of not “needing” your job is freeing indeed. Once your mortgage is paid off, you only “need” enough money for food, clothing, transportation, and utilities.
During FPU, Dave humorously describes his wife’s enlarged “security gland.” He says their emergency fund has an emergency fund!
Avoiding Murphy
The ultimate reason for having an emergency fund is to create a buffer between you and life. This is related to the security gland. Let’s face it… there are going to be rainy days. Having an emergency fund makes it so you don’t get drenched in a downpour without an umbrella.