How much money do I need in my emergency fund?

The definition of an emergency fund:
Money kept easily accessible to cover unexpected expenses.

This definition leads to following questions:

1. How much money to keep?
2. Where to keep it?
3. What kind of unexpected expenses are there? 


Most financial websites recommend to keep 3-6 month of expenses in your emergency fund. That might be the right number. I will do my own estimates and see if I will come to the same result.


I will start with How much money to keep and what kind of unexpected expenses are there?
  
Step 1
First step is to list all expenses. Then mark the fixed expenses and calculate them separately.

Below are two examples which I will use.

First example is for a single person, renting a place and having one car (not paid off yet).

The second example is for a family of 3, owning a house with mortgage and having 2 cars (not paid off yet).





























As you see in the table are the expenses calculated per month and per year (monthly expenses were multiplied by 12 and yearly expenses were divided by 12). 


Fixed expenses are highlighted orange and variable are highlighted blue.

At the bottom of the table are two lines with 3 month and 6 month expenses where only fixed expenses were multiplied by 3 or by 6. This would be the minimum to keep.

I feel that this number must be modified depending on your personal risks and this modification is in step 2 below.  

Step 2
Define what is your most costly risk to cover (not the most probable but the most costly).

1. Job loss - how easily is it replaceable, how likely will you need to relocate?
2. Medical/dental emergency - how much is covered by your insurance, what is the insurance deductible and have you saved enough for your HSA to cover the deductible?
3. Car repairs - don't know much about that but assume up to $3000.
4. Home repairs - probably up to $10,000 - something urgent like roof repair.
5. Unplanned travel - if relatives who live far away become sick or die.
6. Old parents which may need financial support


Increase your savings if:

1. If your most costly risk to cover is the loss of job which will not be easy to replace at the same location and you might need to move. You may need to ad few extra thousands  to the emergency fund ($5,000-10,000 or more, depending on your own estimates). 
In addition to moving to a new place you may have a mortgage which is not paid down yet which will be additional risk.  

2. If you are worried about your health. There may be a prolonged period of non-working which may lead to loss of job. Disability insurance usually have 90 days waiting time before they start paying.  

3. Increase my be needed during recession which may make job loss more likely.



Now about where to keep the money?

The money has to be easily accessible.

Most payments are done by credit card. Some are not.
It is good to keep the money where you can access it within few days.

Option 1:
Savings account
There are online high-yield savings accounts that give more interest than major banks savings accounts connected to checking accounts. For example Dollarsavingsdirect pays 1.5% interest compared to Wells Fargo savings account with 0.01%.


Option 2:
Money market accounts
Money market accounts have similar interest rates to the online savings accounts.


Option 3:
CD
There is a penalty of 3 months of interest if you withdraw money before the CD matures. But that will be not such a significant amount of money. On $25,000 at 1.5% interest that will be $93 will be the penalty for 3 which equals month interest. At 1.5 % your interest for the entire year will be $375 (before taxes). Savings account may have comparable interest rates and are more flexible.


You can check the rates for savings accounts, CDs and money market accounts on www.bankrate.com.


 Any other accounts are not flexible enough. This money can't be invested in stocks or bonds because you may have to sell at a loss, especially in times when market is down.


Start saving in a designated account. If you are married, remember to make it joined with your spouse and have it designated as WROS (with right of survival).