Working out your number
The target is based on essential expenses, not on income. Add up a bare month: rent, utilities, groceries, insurance, transportation, phone and minimum debt payments, leaving out restaurants, travel and anything you would cut the day you lost your job. For many people the figure is sixty or seventy percent of normal spending. Three months is enough if your situation is stable, meaning a steady salary, a second earner in the household and no dependents. Lean toward six months or more if you freelance, work on commission, support someone else, own a home or an aging car, or work in a field where job searches run long.
Where it fits in the order
Saving six months of expenses while carrying card debt at 24 percent is an expensive form of comfort. A sensible sequence runs like this.
- Save a starter fund of $1,000 or one month of rent, whichever is larger.
- Contribute enough to a workplace retirement plan to capture any employer match.
- Pay down high-interest debt aggressively.
- Return to the fund and build it to the full three to six months.
How to fill it
Open a savings account used for nothing else, preferably at a different bank from your checking, so the balance is out of sight and a transfer takes a day. Set an automatic transfer for the day after payday. Even $50 from each biweekly paycheck reaches $1,300 in a year. Send windfalls there until the target is met: tax refunds, bonuses and cash gifts. Keep the money in an insured savings or money market account, not in stocks, because markets tend to fall at exactly the moments when people lose jobs.
What counts as an emergency
The test has three parts: the expense is unexpected, necessary and urgent. A job loss, an emergency room bill, a failed transmission, a last-minute flight to a funeral and an insurance deductible all pass. A sale, a vacation, holiday gifts and the annual car registration do not, and the last two are predictable enough to belong in the regular budget. When you do draw on the fund, use it without guilt, since that is its purpose, and then restart the transfers until it is whole again.
Note An available credit card limit is not an emergency fund. It works as one only until the bill arrives, and card issuers routinely cut limits during recessions, which is precisely when you would need them.
