Money Obedience

We all know that we need to save for some unforeseen emergencies like health expenses or unemployment, but we are often lost about the amount we need to save. So, how much should we save? As with so many things in personal finance, there is not one number that fits all. As a matter of fact, there is not even an exact amount anyone can calculate for him- or herself. Often, the best we can do is to find a range for which we might aim.

One useful rule of thumb is that you put away between 3 and 6 months of your monthly household expenses for emergencies. This is a pretty wide range. Actually, most of us are saving at that range already, without even knowing the rule.

Still unsure of which end of the range to aim for? You can narrow down your target a little depending on your personal circumstances. For example, find the answers to the following questions. Is there only one breadwinner in the family? How many kids are in the family? How old are the children? How secure is your income? Answers to these and similar questions will let you know how vulnerable you are to losses in income – and the more vulnerable you are, the more you may want to aim higher (or for a greater number of months of replacement income).

There are other rules out there that people think are useful here. Some say that we should set aside at least $1000 for emergencies. That seems like an odd number to me. What good can $1000 do? You will not be able to financially survive a real emergency like high hospital bills or long term unemployment on that figure. At least I know that $1000 would not make much difference to me – but I am one to always prepare for the worst-case scenario, and my worst-case scenario comes with a much higher price tag. Still, $1000 is better than nothing. If you’re at the $1000 with your rainy-day fund, it is a great start as a down payment for a larger future emergency fund.

Yet another idea is to add one month’s expenses to your emergency fund for each 1% increase in the unemployment rate. That way, if unemployment is high, you save more, on the assumption that you are more likely to dip into your savings if you lose your job because it will be more difficult to find another one. This sounds like a pretty good idea, generally speaking. But what if you’re one of the first ones facing job losses when the economy has a downturn? You wouldn’t have enough time to respond to the up-tick in unemployment rates because you’re one of the folks contributing to that up-tick! Thus, there’s no way this strategy can work for everyone. You’d have to be one of the lucky ones who kept his/her job when things got dicey in the labor market. And in the current environment you would have to save pretty aggressively to keep up with the quickly rising unemployment rate.

Even though there is not one single correct solution to this problem one thing remains the same. Emergency savings are meant for, well, emergencies. You cannot know what type of emergency will strike, or when it will occur, which is why you must be prepared. Being prepared surely worked for me. I have less than 9 times of monthly expenses in my emergency fund, but it helped to have that much, because I lost my job and had no time to respond to the increased unemployment rate because I was one of the statistics, as they say. And now I am working for less income than I did before, which does not allow me to boost my emergency fund aggressively to keep up with the still-rising unemployment rate. But this does not matter, since I was prepared before a financial emergency hit me. And that is really what it boils down to. There’s no “one size fits all” here. You just need to be prepared for financial emergencies in a way that works for you individually. Be sure to think about it before the emergency strikes!