Emergency Fund Numbers?

[gamecock43]

Everyone has an opinion on the ideal emergency fund size. "3-5 months of expenses" "6 months of expenses" or "8 months of expenses" (Suze Orman).

But what does that mean? My expenses vary depending on the month. And is it my fixed expenses (mortgage/utilities/insurance/HOA) or my monthly spending totals (I tend to spend a large chunk on clothes/eating out and misc things).

I used to think it was paychecks. "Keep 6 months of paychecks stashed away for an emergency." because that is an easier way to look at it than "expenses". But my income is no longer simple- I have 4 sources of rental income and 2 full time job incomes, plus my husband gets bonuses.

I have been putting away $200 a month for over a year now and am up to over $4k. That is enough to cover my mortgages (my only debt) for a few months- but it does not cover our monthly income for even 1 month.

I'm confusing myself. I know my target number needs to be at least double what I currently have, but when I calculate 6 months of debt coverage I am at a low number, around $13k, and when I calculate 6 months of income coverage I am at an astronomical number over $40k.

What do you guys calculate?

[jIM_Ohio]

Needed expenses
do you need clothes?
do you need to eat out?

The purpose of the emergency fund is to allow you to live (financially) if your source(s) of income goes away. Might be disabled, might be loss of job, might be maternity (paternity) leave.


To determine size and amount, you need to look at your risks.

With 3 sources of income (rentals, spouse 1, spouse 2) your risks will be different than mine. How you interpret what really is a risk is up to you. Job stability factors into whether EF is 3 months expenses or 24 months expenses.

For example if you are put in a hospital for 12-18 months, would the rentals "manage themselves" or would you need to hire someone to take care of them- that is a risk, your emergency fund should be able to "fund" that risk if income goes away.

Another example is household dependent on a particular spouse working (because 1 does not get health coverage thru their employer, or one spouse makes a lot more money than the other). This is another factor into the size of the emergency fund.

If both spouses make about same amount, then EF to cover needed expenses for 3 months is the minimum.
If you depend on rental income to cover monthly expenses, then I would add 3 months expenses to the EF. (Basically making EF larger because there is an additional risk).
If one spouse is self employed, then I would add 12 months expenses to the EF.
If income is volatile (because one spouse is in sales for example) then add another 12 months to EF.

Add up what you "qualified for". If sum was higher than 24 months expenses, round down to 24 months expenses (24 months is probably max amount you need in liquid cash).

3 of the 24 months expenses should be kept in liquid cash- 90 day CD ladder, money market or savings account.
Its OK to put some of the expenses (like 3-6 months worth) in a higher yield savings account, longer term CDs or similar. Keep the investment in cash (do not buy shares of anything, put it in cash).
For the remaining 12-18 months expenses, consider a moderate risk mutual fund- like muni bonds, spectrum income (RPSIX), Permament Portfolio (PRPFX) or Wellesley. Those funds range from holding 20% stocks and 80% bonds/cash to 40% stocks and 60% bonds/cash. Main point is to see the cash grow in value, but not take on too much risk as if you lose a job or need the money for an emergency, you want access to it within 7-10 days (and not have to wait for market to recover).



The next step is knowing needed expenses-
mortgage-utlitities-groceries each month
rental costs each month (mortgage and taxes)
and anything else you need to add in, unique to you. Focus on NEEDED expenses.

[skydivingchic]

Here are a few thoughts which might help you. First, decide what your EF needs to cover. My EF is for unemployment or large car, house, medical, or vet expenses not covered by my regular sinking funds for those items. Generally speaking if one is unemployed, there are some expenses which could be cut. You mention spending on clothes - if need be, you could likely cut that expense out entirely for a few months. Same goes for entertainment and other discretionary expenses. So figure out what an unemployment budget might look like and then use that as a basis for expenses. The kicker with unemployment expenses is COBRA. Find out what COBRA would cost, as this is likely to be expensive. In my case COBRA payments would negate savings I would realize from cutting expenses. So to make my life easier, I simply use my monthly budget as a basis for figuring out 6 months expenses. Each month I put aside 1/12 of the annual cost for things like car maintenance, car registration, gifts, etc. So even though any given month I might spend more or less in one of these categories, overall it evens out. Same goes for things like groceries - even though I don't spend the exact same dollar amount each month, I have a good idea how much we spend on average, so that is what gets budgeted.

My emergency fund has two parts. The first part is a few thousand dollars which should cover any "normal" emergency (i.e. most major repairs to the condo or my vehicle, the max out of pocket expenses of my medical insurance, major medical problems with one of my cats). The second part is 6 months worth of expenses as I have outlined above. That part is for unemployment or when my cat has to have surgery right after I had to replace my transmission and all major appliances in the condo.

You should go through an estimating exercise for your rental properties. How much is the mortgage, taxes, and insurance for each? Decide how long a vacancy you need to plan for. Also think about some maintenance expenses and add those as well. While it is impossible to be prepared for every doomsday scenario, it is not unreasonable to think that you might be unemployed for several months at the same time that a rental is vacant or right after some major vehicle repair.

So this is the long winded way of saying that I don't believe EF calculations are as simple as saying X months of expenses or income. Particularly not for people with more complicated situations such as yourself. Figure out what you need/want to cover and then do the best you can to estimate the cost of those items. BTW, my fully funded EF for a single person with no rental property is $25k and I'm considering raising that to $30k. So I would expect that with rental properties, you will be looking at closer to the high end of the range you mentioned.

[jpg7n16]

It's worst case scenario living expenses.

If you lost your job, what would 3-6 months cost you to survive? (8 months is too high to have in cash)

Like Jim said, you'll need food - but maybe not eating out as much. You'd need clothing, but not a $500 dress or 20 pairs of shoes. You could also cut out cable and other stuff if you absolutely had to. You wouldn't be contributing to a 401k, or savings, or paying extra on debts - so you don't count any of that either.

If you base it on income, I'd say have 2-4 months income. Likely 2.5 or 3.

[TheStreetCeo]

(8 months is too high to have in cash)

I disagree that 8 months is too much to have in cash. It may be if you have a ton of expenses but in my case it doesn't seem out of the oridnary.
My total monthly expenses including everything is 4k and I have 8 months sitting in an account for emergencies. I know that i will have 8 months should I lose my job. That's a huge relief.

If I had 3 months, I would want to puke, it can take much longer to find a job than that.

[jpg7n16]

I disagree that 8 months is too much to have in cash. It may be if you have a ton of expenses but in my case it doesn't seem out of the oridnary.
My total monthly expenses including everything is 4k and I have 8 months sitting in an account for emergencies. I know that i will have 8 months should I lose my job. That's a huge relief.

If I had 3 months, I would want to puke, it can take much longer to find a job than that.

See I think this is one of those common misconceptions. Cash and liquid are not the same. Say your monthly expenses were $5000, just for ease of calculation. You can have funds liquid, but not in cash and be covered for years if you lose your job.

As far as acutal legitimate cash - money market, savings, checking accounts - you should have 15k-30k max. (3-6 times $5k)

But as far as whether you wanted 40k (8x $5k) liquid, is different, but it shouldn't all be in cash. It could be in bonds and/or stocks held outside of retirement accounts - where it is easily accessible in a time of need.

Now for the $5k/month expense example. If $15k was the only money they had outside of retirement accounts, that is cutting it close maybe. But if they have $15k in cash (3 months EF) and $100k in a stock/bond non-retirement brokerage account - they are very well covered in the event of a lost job. Just sell a portion of the portfolio if you lose your job.


And the 4%, 7% or 10% you are costing yourself on the extra $10k over the 6 months EF, may not seem like much over 1 year, but over the next 30 years, the 10k being put in 4% bonds would have made 18,955 more than a 1% MM account. 7%-10% in stocks would make 62,644 - 161,015 more.


So my point is, 8-12+ months in reasonably liquid assets, no problem whatsoever (in fact I'd encourage that). But over 6 months in cash - mehhh I don't like it.

[kork13]

I think of my EF in a very simplistic way.

1 month's expenses = sum of all of my budget areas excluding savings. For the sake of simplicity and added security, I include taxes, tithing, charity, and "miscellaneous", though not everyone would.

The number of months' worth of expenses to keep on-hand changes based on your perception of how risky of an employment/income situation you're in. High security: 3 months. Uncertain: 5-6 months. High risk: 8-9 months.

[Snodog]

We go by expenses not income. We are currently spending around $3k per month and if we had an emergency we could probably cut another $300-400. Currently we have around a $24k EF and I'm looking on decreasing that as the employment rate increases. Which may be awhile. Have another 14-15 months in a roth that we could tap if things really hit the fan. I don't count COBRA or unemployment benifits as I figure they would negate each other.

With the rentals I would think you'd want at least 8 months. Also if your cars are on their last leg you may want to increase.

[TheStreetCeo]

JPG7N16-Best post of the day right there. I agree with what you've said regarding the cash on hand. It makes perfect sense to separate some of it into non retirement accounts. I consider myself to be slightly above avergae as far as personal finance is concerned and give my opinion to many people on the subject if they ask for it, but sometimes I neglect my own situation. I'm going to look into separating some of my EF money.

[jpg7n16]

JPG7N16-Best post of the day right there. I agree with what you've said regarding the cash on hand. It makes perfect sense to separate some of it into non retirement accounts. I consider myself to be slightly above avergae as far as personal finance is concerned and give my opinion to many people on the subject if they ask for it, but sometimes I neglect my own situation. I'm going to look into separating some of my EF money.

And for you, given your apprehensiveness about losing a job, I would say the majority of that should be placed into short-intermediate term bonds. Maybe with some stock allocation if the balance gets high enough.

Short-intermediate term Munis if your tax situation warrants it.

[jIM_Ohio]

I disagree that 8 months is too much to have in cash. It may be if you have a ton of expenses but in my case it doesn't seem out of the oridnary.
My total monthly expenses including everything is 4k and I have 8 months sitting in an account for emergencies. I know that i will have 8 months should I lose my job. That's a huge relief.

If I had 3 months, I would want to puke, it can take much longer to find a job than that.

See I think this is one of those common misconceptions. Cash and liquid are not the same. Say your monthly expenses were $5000, just for ease of calculation. You can have funds liquid, but not in cash and be covered for years if you lose your job.

As far as acutal legitimate cash - money market, savings, checking accounts - you should have 15k-30k max. (3-6 times $5k)

But as far as whether you wanted 40k (8x $5k) liquid, is different, but it shouldn't all be in cash. It could be in bonds and/or stocks held outside of retirement accounts - where it is easily accessible in a time of need.

Now for the $5k/month expense example. If $15k was the only money they had outside of retirement accounts, that is cutting it close maybe. But if they have $15k in cash (3 months EF) and $100k in a stock/bond non-retirement brokerage account - they are very well covered in the event of a lost job. Just sell a portion of the portfolio if you lose your job.


And the 4%, 7% or 10% you are costing yourself on the extra $10k over the 6 months EF, may not seem like much over 1 year, but over the next 30 years, the 10k being put in 4% bonds would have made 18,955 more than a 1% MM account. 7%-10% in stocks would make 62,644 - 161,015 more.


So my point is, 8-12+ months in reasonably liquid assets, no problem whatsoever (in fact I'd encourage that). But over 6 months in cash - mehhh I don't like it.

JPG7N16-Best post of the day right there. I agree with what you've said regarding the cash on hand. It makes perfect sense to separate some of it into non retirement accounts. I consider myself to be slightly above avergae as far as personal finance is concerned and give my opinion to many people on the subject if they ask for it, but sometimes I neglect my own situation. I'm going to look into separating some of my EF money.

The main issues with seperating money is to "predict" how big an emergency could exist and also to know how the EF would be replenished should it be tapped. As these factors change, it makes more sense to keep a higher EF than 3 months expenses.

In the $5000 example above (household with 1 months expenses=$5000), that $5000 will cover one months expenses should a job be lost. $5000 should also cover about most major car repairs too.

If monthly expenses were lower (say $2500) and then the same question was asked- would $2500 cover most major car repairs?

The cost of a car repair, say needing a new engine, or getting tires replaced, or needing a new alternator, timing belt, battery and air system are not expenses which fluctuate based on expense level (meaning whether it happens to Bill Gates, Lebron James or Jim Ohio, it going to cost about the same).



My point is that if household expenses are high (say $5k per month) then 3 months EF in cash is probably enough. Probably has some conditions- if there is free cash flow in the budget which could save about $500/mo if EF is touched (so within 12 months the car repair which was paid in cash has been added back into savings).

If the free cash flow does not exist, the person should be starting with an EF which is larger than 3 months expenses.

If household expenses are moderate (say $2500/mo), I would advise the EF to be slightly larger (as a multiple of expenses), as the cost of a new roof on the house, a new engine in the car, a new HVAC system or new hot water heater are costs which are usually not budgeted for, and $2500 does not get much of a car repair (where I live). So 4-6 months expenses for $2500/mo expenses makes sense. I have had 10k of car repair (on 2 cars) within 6 months, so speaking from experience here.


Then add to this the idea of "seperating" money. Let's say a person did the 8 months of expenses (whether their expenses are $5000 or $2500 8 months expenses is enough if income is stable), then the next decision needs to be- how much in cash, and how much in less liquid investments.

This is where the $5000 expense comes in (the worst case). At minimum keep $5000 in liquid cash (regardless of monthly expenses), and for the higher expense household 3-4 months expenses in liquid cash-meaning $2500 in expenses, keep $5000 available, if $5000 in expenses, keep 10k-15k available- the $5000 is the "minimum" size EF regardless of expenses level. Keep this baseline liquid (I use CD ladders, others use money market funds).

After that, the main focus of the EF is to provide a buffer for more than "4 months" (insert timeframe here). Because few emergencies would require 10k or 20k "at once" (liquidity for all 20k would not be needed within 24 hours). So once a minimum amount is in cash, putting the balance into something conservative makes sense to boost return without loosing much liquidity. If its part of EF, I would not advocate putting it in more than 25% equities, but that is an individual decision more than a guideline.


I am a big proponent of having free cash flow in the budget. I often suggest 5% of gross income is short term savings. Even beyond that, I suggest adding line items to the budget for things like
a) new roof (if it costs $4800 every 20 years then add $4800/[20*12]=$10/mo to budget for the roof
b) car (if it costs 24k every 10 years to replace a car, add $24,000/[10*12]=$200 to budget for the car
c) college (if it costs $105,000 for child to go to school and you have 15 years to pay for it, then add $105,000/[15*12]=$700 to the budget for college.
d,e,f- keep doing this for large expenses like new HVAC, new hot water heater, landscaping or any other project you want done.

If you add up that free cash flow, its $910/mo. That cash flow is "savings" depending on how you define it. You may not want to tie up your college monies in a 529 plan if that money might be paying for a new roof in 10 years (what comes first, the roof going or the kid going to college?).

You put the $910/mo into something moderate (PRPFX is my favorate), then pay cash for the car when you need it by selling some shares, then when kid turns 18 and goes off to college, you need some savings, but can then pay for $930/mo college expenses right from cash flow without actually needing to save money for the whole expense. You also don't need to predict college expenses (as much) because you can use current cash flow to pay for the current need.

Which takes me back to the EF topic

If you build in high free cash flow to budget (say around 5% of gross pay or up to $300/mo for mid range expenses), then the only real emergency you have is job loss. Any other expense has "free cash flow" to pay for it, or at minimum contribute to the high one time expense.

If you do not have the high free cash flow, you need to have a higher amount saved up for any of the above and this money would be part of EF.

[gamecock43]

oh there are a lot of ways this is approached I see. I like Jim's idea to anticipate long term costs such as a roof and save up a monthly portion. I have been doing that for shorter term expenses, a year or two out- but can see how easy it would be to plan 10 yrs out.

I also like the idea of trying to anticipate the biggest emergency possible and save according to that. A few months of one of my rental units being vacant would cost about $2500 but a new roof would be $5k.

I'm going to need to think about this some more.

[jIM_Ohio]

oh there are a lot of ways this is approached I see. I like Jim's idea to anticipate long term costs such as a roof and save up a monthly portion. I have been doing that for shorter term expenses, a year or two out- but can see how easy it would be to plan 10 yrs out.

I also like the idea of trying to anticipate the biggest emergency possible and save according to that. A few months of one of my rental units being vacant would cost about $2500 but a new roof would be $5k.

I'm going to need to think about this some more.

See you have risks (with rentals) that none of us do (unless other posters are closet landlords).


Add up your worst case 2 months for each rental

a) former tenant damaged the place
b) you need to repair it
c) it is vacant (associate listing costs and other costs with the vacancy)
d) and might as well replace the roof while its vacant

you have that times 3. If all units are about the same, then its "6 months expenses" for the rental units as a whole, with the plan to rent it out within 2 months whenever its vacant. If 2 months is not enough time, change that multiplier is my guess.
Your worst case should not be this happens to one unit (you should expect 1 of every 12 months is vacant between tenants already- right?)

Your worst case it happens to all 3 units at the same time.

Do you spend the rent you receive, or does the rent you receive just cover your costs with a small profit?

[EconoMutt]

We have $20,000 sitting in a money market account. This gives us close to 6 month's expenses.

I think it's important to look at what expenses can be cut if you lose your job.

We have a emergency plan for when a layoff occurs.

For example, we cancel the cable, gym memberships and dining out until a new job is found.
We also have the option to pay interest only on our mortgage. This is a nice option to have.
You can really conserve cash. It takes discipline though.

Last but not least, the Harley gets put up for sale. (Not my choice. :-)

[jpg7n16]

oh there are a lot of ways this is approached I see. I like Jim's idea to anticipate long term costs such as a roof and save up a monthly portion. I have been doing that for shorter term expenses, a year or two out- but can see how easy it would be to plan 10 yrs out.

I also like the idea of trying to anticipate the biggest emergency possible and save according to that. A few months of one of my rental units being vacant would cost about $2500 but a new roof would be $5k.

I'm going to need to think about this some more.

For your case, I would suggest one budget for your personal expenses, and a separate budget for the business of running rentals.

All income from the rentals should be with the business budget - unless you live off it, then should be an expense to the rental business as salary.

On your personal budget side, calculate personal expenses not related to the rental business. And get 3-6 months whatever you determine. Not just debt service (see posts above from multiple people). Set up your personal EF for this amount.

And then for the business, you need to determine an appropriate cash buffer based on the needs of the business - account for vacancies, repairs, debt service, salaries, etc. Find an appropriate cash buffer (say 4-6 months business expenses) and then begin investing the amount above that into expansion, upgrades, whatever you best see fit for that business. Set up a separate account for this cash buffer.


When you separate the two, it will be clearer about how much you really need. But when you're trying to combine food, gas, rental repairs, insurance, salary expenses, clothing for the kiddos.... it's too jumbled.