What Exactly is an Emergency fFund?
First things first.  Before we answer the question of how much you should save in an Emergency Fund, let’s cover exactly what is an Emergency Fund.  It’s a cash reserve that you have, usually in a savings account, that you use only in emergencies.  As the name implies, you should only tap into or use your emergency fund if you have an unexpected expense that you haven’t budgeted for. 

You use your emergency fund for these larger unexpected expenses instead of a credit card because you don’t want to add to your credit card balance.  Even if you don’t have a current credit card balance, you don’t want to be in a situation where you have an emergency and need to pay for something, but no savings to pay off your card at the end of the month. 

The idea is that your emergency fund has enough cash in it to pay for the emergency without breaking your financial plan.

Emergency Fund: How Much Should I Save?
Ideally, you’re going to set aside enough cash to pay for most unexpected “worst case scenario” type expenses.  You can’t predict how much this will be, but you can use a few benchmarks from some personal finance gurus to determine the right amount for your emergency fund.

Dave Ramsey, author of Total Money Makeover, advocates starting with an Emergency Fund of only $1,000. Note: He advocates having an Emergency Fund of $500 if you make less than $20,000 a year.  Dave argues that $1,000 in cash will take care of most unforeseen expenses, which means all your other money can be funneled toward paying down your debt.

I agree with Dave’s advice. 

Emergency Fund versus Paying Off Debt
If you’ve got a lot of debt – particularly credit card debt – it’s not going to make much financial sense to keep a bunch of cash in a savings account.  Why?  Because you’re playing a loser’s game.  Why sock away hard-earned cash only to see it grow at 1 percent a year while some megacorp credit card company is banging you out for anywhere from 14 to 24 percent interest per year?  That’s a sucker’s game if I ever saw one.  If you sock away 3 to 6 months of expenses into a savings acount but you’re drowning in debt, you’re going to drown in debt for a long time.

So this is why I think Dave Ramsey and his $1,000 Emergency Fund to start makes sense.  Save this amount of money and you’ll start to sleep better at night, especially if you’ve never really had any money in your savings account before.

Once you’ve got a debt repayment plan going, you can focus on adding money to your Emergency Fund.

Emergency Fund: The 3 to 6 Months of Expenses Rule
Most personal finance books I have read have recommended that you save between 3 to 6 months of your monthly living expenses in your emergency fund.  The reason this number is suggested is that it is believed that most people, should they lose their job, would be able to find a new job and start it within 3 to 6 months.

I think this advice is good, but ultimately it’s up to you to figure out how much money to put into your emergency fund.  If you have a career that is in high-demand, then you might need less of an emergency fund.  If you’re the sole breadwinner in your family and it would take a while to find a new job should you lose yours, then you might want to save more than 6 months of living expenses.

In short, there is no “one size fits all” approach to emergency funds, but if you’re trying to figure out how much should you save for your emergency fund, the 3 to 6 months benchmark is a good place to start.

Photo courtesy of jstruan