An emergency fund is a pot of money that serves as a ‘safety net’ for any unforeseen expenses or life changes such as, the loss of a job, a major repair to your car or home, or an illness that keeps you out of work for longer than expected.
These funds are often kept in easily accessible accounts, available to use instantly if the need arises.
It’s often recommended you keep around 3-12 months necessary expenses in this pot, allowing you to cover for any prolonged periods of unemployment until you find another source of income.
Necessary here meaning unavoidable expenses; this does not include purchases like your morning coffee treat before work.
Personally, I tend to keep a little more than that in mine.
I keep around 12 months of post-tax earnings in cash, measured against the first wage I was on in my first full-time job out of university. This was the lowest full-time wage I have been on so far, while still having to pay rent and bills.
My theory is that if I could live off of this amount, back then, while on the lowest wage I’ve ever earned, then, in a time when I’m depending entirely on my emergency fund, I should be able to support myself for exactly a year (this being the worst-case scenario) again on this wage. This is assuming my expenses haven’t grown substantially, but then again, being part of the FI community I’ll always be looking to keep these as low as possible.
Being slightly higher than the average emergency fund, this amount obviously accounts for more than just necessary bills.
Having a fund this size allows for a few small luxuries when morale will be at its lowest point (e.g. long-term unemployment) and not have to turn down every social invitation I receive.
Obviously, I won’t be going on lavish holidays or buying new luxury items during this period, but it allows for the simple things, like going for a coffee with a friend or getting out of the house on the odd day trip to a nearby national park.
These things will be vital while looking for work to keep positive and motivated to push on even though life feels like it’s constantly against you.
Furthermore, a fund this size, while allowing me to maintain a fairly unrestrained lifestyle, still means I can keep all investments in the market by not having to sell anything. My investments will continue to work for me even while I’m not at my most financially prosperous.
With this approach you need a relentless commitment to only paying yourself 1/12th of this emergency fund every month.
The overall sum is quite significant so it could be tempting to dip in a little more than you budgeted for, but in order to allow it to last the full 12 months, and for it to be maintained, you need to be able to moderate effectively and consistently.
Holding an emergency fund of this size also brings about the question of inflation eroding the cash over time which is a totally understandable concern, but an emergency fund isn’t there to be creating wealth or making you rich off of the interest, it’s there so you can support yourself when shit hits the financial (and sometime literal) fan.
This is, of course, worst case scenario. It’s likely that job hunting won’t take the full 12 months, but it’s always good to be prepared.
If your job search only takes six months, then you’re able to start rebuilding it from 50% rather than from scratch.
Updates to the useful links section…
You may or may not have seen I have updated the useful links and resources section so it’s a lot easier to navigate having been divided into subsections depending on the type of personal finance resource you’re looking for. I have also added quite a number of useful links since my last update. Hope you find it useful.