Anyone setting out on the road to financial security, or perhaps walking through a periodic checkup of their current financial status, should make sure they have a solid emergency fund.
A question we are often asked is: just how much cash should I set aside for my emergency fund? As is the case with most important questions, the answer is that it depends entirely on the situation.
Long story short, the less secure your income may be, and the more people that are dependent on your income, the larger your emergency fund should be.
A good way to start out this thought experiment is to consider for what exactly would we need this emergency fund. One pitfall is that many people use their emergency fund for non-emergency events, such as large expenses like a big holiday, or remodeling part of their kitchen. In some cases, if you have done your homework and have sufficient health insurance coverage, the emergency fund shouldn’t be needed to cover the costs associated with illness and injury (it’s almost always cheapest just to get adequate insurance beforehand).
Emergency funds typically are here for our real emergencies. Ones that prompt questions such as…
–If you lost your job, how many months would it take to find another one?
-What are your unavoidable monthly expenses? (rent, food, utilities, etc..)
-If there was a family emergency, how much would it cost to fly the family back to your home country?
-If you or your partner is free-lance or part time, how much would it cost to get through short periods of reduced income?
Where should I hold my emergency fund?
Your emergency fund should be somewhere that you can easily access it in an emergency. That means an ordinary cash bank account for making big monthly payments out of; ideally with an easy access ATM card for emergencies (an ATM card that can be used internationally is ideal). You shouldn’t consider any investment accounts towards your “emergency fund”, and if you really want to be strict you shouldn’t even have the cash in a fixed-term bank deposit.
Given how easy (and often free) it can be to open a bank account, some people opt to open up a separate account specifically for their emergency fund. This will help to section off their emergency fund from other short term savings (planning for big holidays, or big purchases within 1-3 years), as well as medium and longer-term accounts.
At the end of the day, there is no perfect answer as to how much to keep in an emergency fund. Much of it will come down to having the discipline to put a small chunk of cash aside for a rainy day, and not to touch it unless you really have no other option. This then frees you up to take a closer guilt-free look on how to allocate our remaining savings.