We consider what financial challenges young adults are most likely to encounter and how much to save in an emergency fund.
What types of emergencies?
When we use the phrase “financial emergencies,” what are we talking about? Obviously we’ll never be able to predict future hardship but we can be realistic about the types of emergencies likely to come up in our lifetime.
Most likely financial emergencies:
- Medical expenses
- Home repairs
- Car repairs
- Job loss
An emergency fund is not your only defense against a financial crisis.
Medical expenses? Make sure you have health insurance. Home repairs or damage? Either home insurance or renters insurance can help keep this from becoming an overwhelming burden. Car troubles? Get full coverage car insurance. (We’ll post more about these in the future).
This leaves job loss.
Job loss isn’t something you can prepare for other than unemployment. Of these top causes of financial emergencies, job loss is one of the hardest to prepare for, making it the focus of most emergency fund guidelines.
The 3-6 months rule
A common rule of thumb for emergencies is to have three to six months of living expenses saved. This idea takes into consideration that lifestyle is relative. It’s important to consider that saving $10,000 means something very different to someone living in the pricey suburbs of Los Angeles compared to another in rural western New York. Simply providing a $10,000 goal doesn’t take into consideration cost of living and individual habits. The 3-6 month rule allows for flexibility and simultaneously provides a time frame to get back on track in the event of a job loss.
It is possible to interpret this rule in a few ways. Are you talking about everything you spend in a normal month when you’re not experiencing a crisis? Or just those essential expenses you need to get by?
Perhaps in your normal monthly budget you spend about $4,000. This rule would suggest you should have $12,000-$24,000 in your emergency fund. To many people this seems excessive – $24,000 could be a down payment on a home!
Identify essential expenses
We believe it’s safe to assume that if you were in a true emergency you would not spend the same amount you would in your normal day to day life. To help you find a realistic number consider what you need to function as an individual or family each month. What expenses do you consider essential?
Here’s a list of possible essential expenses:
- Gas money
- Childcare (unless during a job loss this allows you to watch the kids)
- A little extra for unexpected costs
It’s not logical to spend money on entertainment, restaurants, new clothes or vacations when you’re in an emergency budget scenario. If your normal budget is $4,000 in spending each month it’s likely that your essential expenses only make up 50-60% of your average spending. In this case your monthly necessities would be around $2,200 meaning an emergency fund of $6,600-$13,200.
See how confusing even the 3-6 month rule can be? Saying ‘between 3-6 months worth of expenses could mean anything from $6,600 – $24,000 for the same household.
It’s important to think critically about your lifestyle and determine a number that makes sense for your situation.
Always up for discussion
This conversation should happen multiple times in your life. Whenever you make a significant life change, move to a new area, buy a home, have a child – revisit your emergency fund number. Determine if you need to adjust it based on your new expenses. Having a plan to save for emergencies will reduce your overall stress and limit the anxiety surrounding a difficult season.