How much to put in your Emergency Fund (3 or 6 months of living expenses?)

When it comes to Emergency Funds, a common question is how much cash to put in? How much money should you be saving for a rainy day? Today we're looking at how much to put in your emergency fund, where to keep your emergency fund and how to save up your emergency fund quickly.

How Much to Put in Your Emergency Fund

How much you put in your Emergency Fund depends on what it will be used for and how often.

We will go through the process in 3 steps: 1. Determining a purpose for your emergency fund.

2. Creating a bulletproof budget.

3. Deciding 3 or 6 months (analysing your risk tolerance).

Step 1: What Will Your Emergency Fund Be Used For??

Firstly, why do we need an emergency fund?

An Emergency Fund stops you from going into debt when life deals you a bad hand.

But it is more than simply a practical asset, I see it as an emotional buffer to my investment journey.

Investing and wealth building is an intensely emotional journey and most of our financial decisions (good or bad) are rooted in an emotional response. Most often, the triggering emotion is fear.

An Emergency Fund serves to dull the fear and allows us to make more practical decisions that aren’t purely based on mere survival.

What classifies an emergency?

For me, an Emergency is something I could not have foreseen, something I could not have budgeted for. It's important to consider all possible emergencies when deciding how much cash to put aside. This way, you will make sure you have enough money to adequately cover any situation.

You might be thinking... if an emergency fund is only for certain situations, how do you cover sporadic expenses like car rego, insurance or small random expenses?

The answer lies in setting up a bulletproof budget (or "money management system" if you don't like the word *budget*).

Step 2: Set Up a Bulletproof, Realistic Budget

Keep your emergency fund for actual emergencies and account for predictable expenses in your regular budget by creating a realistic budget.

1. Download the last 3 months of transactions from your bank account in an excel file.

2. Label all of your expenses in categories so that you can figure out EXACTLY where your money goes.

3. Account for annual and 6 monthly expenses that might not be noted on the last 3 months of transactions. E.g. Car Registration, Insurance, Dental work, Utilities etc.

4. Work out what all of your expenses cost you each pay period.

5. Set aside money every pay period for these expenses.

Without a realistic budget, you have to dip into your emergency fun whenever expenses arise. This creates stress as you constantly have to replenish it.

With a bulletproof budget, you can simply set and forget your emergency fund and it will be able to serve its purpose and actually give you peace of mind.

Step 3: Deciding How Much to Put in Your Emergency Fund - 3 or 6 months?

The general rule is to put aside between 3 - 6 months of living expenses.

But how do you decide whether you want 3 months or 6 months?

Consider the following:

1. Is your income volatile or stable?

2. Do you have "job security"?

3. Are you a business owner or freelancer?

4. Do you have children or dependents?

5. Do you own a car?

6. Do you have health issues?

7. In the case of an emergency, do you want your Emergency Fund to cover your current lifestyle? Or are you happy to reduce your lifestyle if needed?

8. Are you capable of cutting expenses in an emergency or are you already on a bare-bones budget?

It really comes down to your own risk tolerance and your comfort levels. What amount would you feel comfortable with?

Once you've taken all of the above into consideration, you can work out what 3 months of living expenses are (refer to step 2). What is the actual figure?

Once you know that figure, you can make a decision based on how you feel - after all - having an emergency fund is as much about managing your emotions as it is managing the maths.

If you feel like 3 months is too small, you might consider 4, 5 or 6 months worth.

If you have a higher risk tolerance, you may wish to only hold 3 months of expenses in cash and start investing sooner.

Personally, my husband and I opted for 6 months of living expenses in our Emergency Fund. We are both entrepreneurs so our income varies from month to month. We feel more comfortable with 6 months of living expenses in our emergency fund.

Where to Keep Your Emergency Fund

So, you know how much to put in your emergency fund - now the question arises where to put it? Everyone should keep their emergency fund in a high interest savings account.

Some people consider investing their emergency fund, and it can certainly be tempting, especially when enticed with a potential 7-8% annual return. BUT

The point of an emergency fund is to STOP you from going into debt, NOT to make you rich.

(Although it certainly will help you become rich inadvertently due to the psychological & practical benefits).

It is important to keep your emergency fund liquid so that it can be easily accessed quickly, without causing stress.

So, personally, I have put mine in a high-interest savings account with zero fees. (Be careful to avoid sneaky variable introductory interest rates).

How to Save Your Emergency Fund QUICKLY

You know how much to put in your emergency fund, where to keep it - now, you might need to save up some cash in order to fund it!! Saving your emergency fund can feel like a drag and often we are eager to get started with investing ASAP.

But in my experience, it's easier to focus on ONE THING AT A TIME. Get that Emergency Fund fully stocked, and then switch your focus to investing.

Here are my 3 top tips for saving quickly:

1. Make extra cash.

Use platforms like FB marketplace or Airtasker (I made $2000 on FB market place in 2 months and $450 from Airtasker in just 2 days).

2. Focus on one thing at a time. Put all your manpower, all your effort towards bulking up your emergency fund. Not only will you achieve your goal faster, but you will be motivated to get it done QUICKLY so that you CAN move on to more exciting things like investing.

3. Set up a realistic budget. This is crucial to staying consistent. Consistency is everything. It's better to save a smaller amount each and every single week than to over-commit. If you over-commit you'll find yourself saving 75% of your pay check one week and then dipping into your savings the next.

It's like taking one step forward and 3 steps back.