When planning for the future, a key question you need to ask is: how much should you have in emergency savings?

This topic is different than “how much do I need to save to buy a house?” and “how much do I need to save for retirement?”  What we’re really asking here is how much should you have in emergency savings (aka cash reserves)?

The rule of thumb is that you should have four to six times your monthly expenses in savings. But if you’re reading this blog then you were probably expecting to learn more than a rule of thumb.  So let’s dig deeper.

Look at Your Expenses

First, let’s talk about monthly expenses.  We are not suggesting that you need four to six times your income or salary.  That’s because your income doesn’t equate to how much you live on; it’s related, but not the same thing.  So how much do you live on every month?  In other words, how much does it take to pay all your bills (mortgage/rent, car payment, utilities, insurance, food, etc) in a month?  Don’t include your contributions to savings and retirement accounts here, just basic living expenses.  Hopefully your monthly expenses are less than your income.  So now you should have an idea of your monthly expenses.

Evaluate 4-6 Months Months of Expenses

Next, let’s discuss this four to six months’ worth of expenses.  Why is this a range and not a flat multiple?  Well that’s because your situation is unique.  Here are some reasons you probably need closer to 6x your monthly expenses:

  • You have a high debt load (including but not limited to credit card debt);
  • Your household only has one income (or income is very lopsided between spouses/partners);
  • Your income varies every month;
  • You have children or other financial dependants.

These are all reasons that you have a higher need for liquid savings.  On the other hand, here are some reasons that a lower multiple, like 4x, might be sufficient:

  • You have a dual income household;
  • You have passive income, like rental income from real estate;
  • You currently save a lot of your income (i.e. your expenses are much lower than what you earn).

If this describes you, then you’re probably okay with a little less in savings.

Where to Hold Your Emergency Savings

Now we’ve determined your monthly expenses and if you should use a lower (4x) or higher (6x) multiple.  The next question is where should you hold this emergency savings?  This cash should be somewhere both accessible and safe.  Good types of accounts are savings and money market accounts available at your bank. If your discipline is lacking (no judgement implied, we’re all susceptible), then you might want to choose a bank separate from where you have your checking/current account.  Poor account choices are a CD (because it’s not truly liquid), a traditional or Roth IRA, and your 401k (because there are tax implications and more limited access).

You might complain that you don’t get any interest or return in your savings account.  My answer is, that’s not the point!  The main reason to have emergency savings is to have access to funds in an emergency.  Earning interest is the icing on the cake, but it’s not the main reason.  Many banks pay 0.1% or worse on savings – which I agree is dismal.  At the time of writing this blog, I found a number of banks offering up to 2% on your savings (https://www.bankrate.com/banking/savings/rates/).

Here are two more important tips. Keep in mind that your emergency savings should be in the country where you live and the currency of that country. Also, if you deplete your emergency savings below your ideal number, then remember to refill it!

Hopefully you now have a better handle on what amount of money you should keep in savings.  But remember – these are just guidelines.  If you feel most comfortable with a year’s worth of expenses, then that’s the right number for you. The goal is to have enough for to cover unexpected expenses or a gap in income but not having an excess in savings that will lose purchasing power over time due to inflation.  So when it comes to emergency savings, having balance is key!

If you need further help with your emergency savings, view our financial planning services. 

Plan First Wealth is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.