How Much Should I Save in an Emergency Fund?

Chia-Li Chien, PhD, CFP®, PMP®, Jan. 28, 2019

Thirty-five days of U.S. government shut down for political reasons at the beginning of 2019! What a way to start the new year! My brother-in-law and his wife both work for the federal government; the furlough impacts one of them. But there are 800,000 government employees, and many more contractors that have jobs but are without paychecks in this political mess. My heart goes out to every family that is experiencing unjustifiable political turmoil. Local food banks and volunteers are all helping these families to get through the uncertainty.

According to a 2015 study from The Pew Charitable Trusts (The Pew Charitable Trusts, 2015) (The Pew hereafter), the median cost of a financial emergency was $2,000 or half of the monthly income. The study found that the median household had less than $4,000 in liquid savings. The rule of thumb when counseling clients in financial planning is an emergency fund between three and six months’ salary depending on the income level. I found that families who diligently saved up for the emergency fund are also well prepared for an unexpected financial downfall. Additionally, they are good savers in retirement and other investments to accumulate their overall assets.

There are so many reasons that families face financial emergencies. The Pew study defined the “financial shock” as an irregular financial deficit that reduces the income, such as car repairs, home repairs, fluctuating work hours, pay cuts, or even health emergencies not covered by insurance. Although these uncertain situations do not happen often, one setback could take a family a long time to recover financially.

Like many families out there, my family is no exception to delaying any type of house repair until it’s necessary. Well, summer of 2018, our 14-year-old AC finally decided to stop working. You would think that in our relatively new home the AC should last forever. The reality is that no companies make any machine that last forever anymore. We had quotes from Costco, and other local firms from a previous year, but my husband, TC, wanted to go to his guy. Yup, he’s got a guy!

Our financial shock was $10,000 cash since his guy was a small firm and did not provide any financing. One of the disadvantages of being a financial expert is that family members like my husband know that I have a stash somewhere that can take care of events like this. He was right, but it was still painful, because at the same time, I was relocating to CA for a tenure-professor job. We had to pay up all the moving expenses before the university reimbursed us a portion of them.

The Pew’s research found that 19% of the respondents took more than six months to recover. Higher income families have higher financial emergency costs compared to lower-income families. But it took three times longer for lower-income families to recover compared to higher income families. In my summer 2018 experience, yes, it took about two months to recover the emergency funds, but it was not easy emotionally. Because we were too accustomed to a particular lifestyle, the feeling of not having my emergency fund in full was stressful. But we did not have any reduced income like the federal employees or contractors. We simply used our emergency fund and moved on with life. But many of these families had to take out a loan just to make ends meet.

So, you ask, how much should I save in my emergency fund? How many month’s salary depends greatly on your ability to land your next job. Let’s take as an example one of my clients who is an executive of a Fortune 250 company. Most executives have 12- to 18-month contracts and potentially have severance up to the same number of months. The higher up your position is, the longer it takes to land your next job. I recommend the following guidelines for clients in the emergency fund:

Business owners that have less than $1 million in revenue, save up to six months after-tax salary. In your company, have at least three months’ worth of business expenses.
For owners that have between $1 and $5 million in revenue, save up to twelve months after-tax salary plus six months’ worth of business expenses.
Rank and file employees, the older you are, the longer it will take you to find something. Therefore, if you’re above age 45, six months after-tax salary is a must. If you’re younger, you might get by with three months of emergency fund.

There is no magic bullet of how much an emergency fund will cushion the emotional stress you feel when you are in a big or small financial shock, but having enough in emergency fund savings as well as other types of liquid accounts could help you feel at ease. Like my AC and relocation situation, I was stressed, but I knew that I would save up the emergency fund again soon, which I did. But my husband definitely felt the stress from me over the AC replacement and relocation during last summer. So, I feel for the federal employees and contractors that missed two paychecks. Some of you may get your paychecks back, and some may not. I sincerely hope that you put your emergency fund to work and continue to replenish the accounts.

No one will take care of you except you, and you must have enough emergency funds to meet any unexpected financial shock.