The goal of an emergency fund is to stay out of debt. When a catastrophe strikes (injury, disability, job loss), you do not have to incur debt to stay afloat. That would put even more pressure on you in the future.
How much do I need?
A good rule of thumb is to have three month’s income (salary, wages or earnings) in reserve for emergencies. Can you forfeit your salary for three months? Most of us cannot. If you work in a high risk job, physically or in terms of maintaining or replacing your job, six months income is the best emergency fund.
Why salary and not cost of my bills?
Like it or not, your bills are not all you pay in a month. You have incidental expenses which you also cover with your salary.
- A new tire or car repair.
- Fluctuation in the cost of your bills.
- Home repairs.
- Medical expenses.
My salary is more than my bills…
That is terrific! Your emergency fund will grow faster. Once your bills are paid, put the rest away for a rainy day. By all means, bank the six months rather than the three.
…But not if I pay credit cards.
If you already have debts, the sooner you eliminate bad debt the better. While you pay off your debts, save a smaller amount. Do not choose one or the other. This will help your credit score and allow you to use credit if your emergency fund has not grown large enough yet.
I do not have that much discipline.
Oh, yes, you do! Write yourself a bill. When you pay your home bills, pay yourself. Even if you are only paying yourself $10 per paycheck, the money will build up.
Next time, we will look into ways to start saving.
See all posts in the Emergency Funds Series.