Life is unpredictable, we can have great intentions but then “life” happens. This “life” stuff can prove to be pretty frustrating. Let’s say you just got done completing your net worth calculation and are fired up to make a change this year. You have some debt on your credit card, and you are sick of paying the minimum balance for what feels like a never decreasing balance, so you decide to start paying down your debt…not a bad intention, but it should not be the only priority.
Let’s take an example; nerd wallet says the average American household credit card debt is $16,748. Since many millennials have yet to form a “household” let’s cut this number in half $8,374. If you are paying 20% interest on this debt a year that is $1,507 a year of simple interest! There is a good reason to fight to pay this debt off, but at what cost with no emergency fund. What I tend to see is if you have no cash savings you start to make progress and pay down a chunk of the debt, but then “life happens” your car needs repairs. If you have an unexpected cost and no other savings when your vehicle is your only method of transportation you will have to put the bill where… well probably on your credit card! So you end up backtracking instead of making progress. This can be very discouraging, and often makes people want to give up paying down that credit card when it feels like the balance will never be zero.
Instead of the all or nothing approach admit that you need to be disciplined enough to have an emergency stash. If having cash burns a hole in your pocket, I recommend finding an online bank and setting up a separate account that requires just enough work for you to keep your hands off the emergency cash. This first step is important if you want to build any sort of real wealth. This not only will help you succeed with your financial goals but gives you a great peace of mind that if issues come up, you can handle them. After you admit that having some liquid cash is important the next question is how much is enough?
How much makes sense for you?
How much is needed will be very different as most subjects are in personal finance. It is PERSONAL depending on where you are in life and what your goals are. Let’s walk through a couple of different scenarios to get a better feel for how much emergency fund cash is needed.
Example 1: The new grad.
The new grad just finished school and has some student loans that need to be taken care of as well as a small credit card debt from a summer trip with friends. Luckily they have gotten a degree that landed them a decent paying job, and they are smart, so they read Damn Millennial and understand that this debt needs to be squashed to build true wealth. They also need to move for their job, so living at home is not an option. They share a place with two other roommates, and their rent is $600. In this scenario, this person can defer their student loans for six months at which point they will owe a monthly payment of $450. They make the choice to continue to live like a college student and are fortunate to stay on their parent’s health insurance until 26. The credit card debt has a monthly payment of $100. They will eat cheap, and try to limit the amount of money they spend on entertainment until the credit card bill is taken care of.
In this scenario, I would recommend an emergency fund be built up as fast as possible to $2,300. This comes out to covering about two months of expenses. They will be early in their career and if they don’t perform can be let go, so it is important to have a buffer. Also, they are most likely driving an older vehicle that will need repairs over the next couple of years while they work on paying off the debt. At this age many people are still willing to be flexible as “life” happens so it is important not to get too worried about holding much more cash than this. More importantly, the new grad should be humble and willing to make big sacrifices early and work on paying off the debt and then building a bigger emergency fund before moving on to investing.
Example 2: Five years into a career.
In this scenario, we look at someone who is a bit more established in whatever field they are working in. Maybe initially they bounced around looking to find a company with the right fit, or they have just stayed put in the first gig they landed out of school. Some people in this category will have gone back to grad school and started work again after completing their program. Others will take a while to get to this point as it is easier said than done to find something you enjoy and stay put for five years in the age of instant gratification. This age group can be anywhere from 28-35 this piece is not important just a perspective as there are endless roads someone can take.
Most people at this point will hopefully be making some traction, maybe it took a job hop or two, but you have advanced in your role and are earning more than when you just started. The danger of this is that you may have adjusted your lifestyle accordingly. Frequent nights out to blow off steam, upgraded vehicles and homes can all add up. This is why it is important to see how much your lifestyle is costing you. Many financial experts recommend an emergency fund of anywhere from 3-12 months. I think that this is too generic as some people spend more or less than others so it comes down once again to the personal situation. If you are someone who feels the need to buy new things to make it through a stressful week or live in the nicest area of town that is okay, it is just important to realize your emergency fund will need to be much larger than those who are thrifty.
Some other major factors that need to be taken into consideration are do you have any children or other dependents that count on you? What type of job are you working? Is it in a field that has been stable or is it prone to industry shake-ups? If you were laid off tomorrow how long in your local market would it take to find another position? These are tough questions but important because they all can be a factor at some point in your life. You are not immune to other major life problems either. Many people every day have a life changing event that can turn into a financial burden for years if not prepared.
For this example, it is important to get a pulse on where your personal situation lies. If you feel there is a lot of uncertainty and your expenses could shift quickly, I would aim towards the 12 months. This also applies to those who are no longer enjoying their role and are looking to make a career change or possibly start their own business.
If things are going great at work and you feel you have a good grip on your expenses and managing your monthly cash flow, then three months should be fine. Just be honest with yourself and don’t get caught in a bind by not having enough tucked away.
This exercise is not to create a feeling of fear. Instead, it is meant to empower readers to stash cash and feel confident that they can face these issues as they come up. This turns the “life” events from disasters to speed bumps. Once you have established your emergency fund, that’s when the fun part starts. You can pay down large debts freeing more cash flow and then ultimately invest in what you are passionate about.
What Are Your Thoughts?
- How much do you have saved for an emergency?
- Have you had an emergency come up in your life where you were happy to have some cash?
- What do you think the ample amount is for an emergency fund?