Calculating the right amount to maintain in an emergency fund is an important exercise. Why? Because you don’t want to be caught without enough to cover your emergencies, leading you to use expensive credit cards or pay taxes and penalties to withdraw from your retirement accounts. Also, having too much in a rainy day fund hurts your long term planning. These are funds that could be invested instead of sitting in a savings or checking account.
A general rule of thumb is three to six months of monthly living expenses. While this is a nice starting point, there could be other important factors:
- Health: Do you or your family members have health concerns that could result in lost time at work? Could you be needed to take time off to care for a relative?
- Job Security: Some jobs are more secure than others. Is your family dependent on one income earner? Does your income fluctuate?
- Budget Flexibility: Are you able to “cut back” if necessary? Do you have a lot of monthly payments?
- Investment Liquidity: Do you have assets that can be converted to cash? Are all of your assets in real estate or retirement plans?