Did you know that only about 39 percent of Americans had enough money in savings to cover a $1,000 emergency? According to that same survey, another 19 percent of respondents planned to pay for their emergencies with a credit card.
It may seem obvious, but to avoid going into more debt, you should have an emergency fund.
Yet, regardless of whether you’re fresh out of school or in the middle of your career, starting an emergency fund from scratch can be a bit daunting. You may be wondering how much you should be saving each month or whether you need to aim for a certain amount. To help you sort it all out, take a look at our basic primer on the ins and outs of saving enough into your emergency fund.
What is an emergency fund?
An emergency fund is a bank account that is set up to help cover large, unexpected expenses. This can include car repairs, medical bills, or living expenses in the event of a job loss. An emergency fund is almost always kept in a separate savings account and the money is typically off-limits unless you need it for a true emergency.
How much should I save?
There are a myriad of opinions on how much you should have in your emergency fund at any given time. Some experts recommend setting aside at least three to six months worth of living expenses. But it may work better for you to start small – with a dollar figure that you can achieve. Here are a couple of different strategies to help you start saving:
Aim to save $1,000 and go from there
In this case, think of your emergency fund in terms of saving up a certain goal. This will help you stay motivated. Some financial experts, including Dave Ramsey, suggest starting with a goal of $1,000. To stay accountable, you can create a line item in your budget to help you earmark funds toward this monetary goal.
To help you save up even faster, you can try automating. With a Chime bank account, this is easy as you can save money automatically. For example, each time you make a transaction with your Chime Visa Debit card, the amount will be rounded up to the nearest dollar. That round up amount is then deposited into your Savings Account. Taking things a step further, you can elect to automatically move 10 percent of each paycheck straight into your Chime Savings Account.
Use the 3/6/9 rule
Once you’ve banked your first $1,000 into a designated emergency fund, you may want to try saving, even more, using Learnvest’s 3/6/9 rule. This rule helps you determine how much to save based on your particular situation.
For example, saving three months worth of your take-home pay may be the ideal amount to sock away if you’re a single renter with a steady paycheck. However, if you’re a married homeowner with children and you and your spouse both work, you should probably aim to save up to six months of the higher earner’s take-home pay.
But what if you or your spouse is self-employed? While some months may be lucrative, other months may be more of a struggle. If this is the case, then it likely makes the most sense to save nine months worth of your average take-home pay. Simply put, the more volatile and unstable your income, the more you should be saving to help give you peace of mind.
Calculating a precise amount for your emergency fund
Interested in figuring out exactly how much you need to have in your emergency fund? You may want to check out this formula from a Money Under 30 blogger, as reported in U.S. News & World Report.
This takes into account four factors: your monthly expenses, your income volatility, your income commutability (how long it would take you to find a similar job if you lose your job), and the amount you have currently saved up. Here’s a breakdown of how to figure out your job volatility and income commutability.
- Job volatility. To find your personal income volatility “score”, you’ll need to look at your last 12 months of income and hone in on your highest and lowest earning months. Let’s assume you earned $6,000 in your most lucrative month and $2,000 in your slowest month. You would then use this formula to figure out your volatility number: $6,000 (highest) – $2,000 (lowest) = $4,000. Then, take the $4,000 and divide it by your lowest earning month. So, this would be $4,000 divided by $2,000 = 2. Voila! Your income volatility number is 2.
- Income commutability. To zero in on this figure, you’ll need to take the total years you’ve been working and multiply that number by .5. After that, you’ll add in another .5 for every $10,000 you earn over $40,000 each year. So, if you earn $40,000, you’d add 0. If you earn $50,000 you’ll add .5. If you earn $60,000 you’d add 1 and so on.
As an example, let’s assume you’ve been employed for 10 years and earn $60,000. You would then use this formula to figure out your income commutability: 10 (years worked) multiplied by .5 = 5. Then take 5 and add the amount that represents how much you earn over $40,000. In this case that would be $60,000 – $40,000 = $20,000. So that would be 5 + 1 = 6. And there you go. Your income commutability would be 6.
With these figures at your fingertips, you can now figure out how much you should have in your emergency fund by plugging your numbers into the following formula: (Minimum monthly expenses multiplied by income volatility multiplied by income commutability) – existing savings = your ideal emergency fund amount.
For example, let’s assume your minimum monthly expenses are $3,000 and you currently have $4,000 in your emergency fund. Using the income volatility and commutability figures from above, you’d plug the numbers in here to figure out your ideal emergency fund: $3,000 (minimum monthly expenses ) multiplied by 1 (income volatility) multiplied by 6 (income commutability) = $18,000. Then take $18,000 and subtract how much you currently have in your emergency fund. So this would be $18,000 – $4,000 = $14,000. This means you should aim to save $14,000 into your emergency fund.
What’s the right amount?
With a lot of different advice floating around, it’s hard to determine the best method for calculating how much to save into your emergency fund. The most important thing is to start saving as soon as possible. This way, you’ll have funds available when you need the money the most.