🎙 There are a lot of opinions out there on how much you need to save up for emergencies. What if most of those financial experts are wrong? But then how much do you really need? The answer might shock you! 🤔
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Hello, and welcome back to the Girl on FIRE podcast!
On this weeks’ episode, I want to go back to basics and talk about one of the most important things you need to have in place at the start of your financial journey and any journey towards financial independence — your emergency fund.
Your emergency fund is how you protect yourself financially from emergencies that pop up like your car breaking down, or losing your job.
It’s usually for things that you can’t predict and you don’t really have any control over.
But just because you can’t predict them it doesn’t mean you can’t be prepared. Because life rarely works out according to our best laid plans, right?
Things change, things go wrong and all of a sudden you find yourself up a creek without a paddle — that’s just life, and we’ve all been there at some point.
Now, most financial experts out there advise you to have an emergency fund, which they absolutely should.
But they also give you rules of thumb tell you how much you should aim for.
I actually very passionately disagree with a lot of that advice which is why, in this episode, I wanted to focus on how much you really need to save for emergencies.
Because chances are, it’s going to be very different from what other financial experts would tell you.
What ‘financial experts’ say
The standard approach
So, if you’re out there on the internet, you’ll notice the majority of financial experts recommending 2 things when it comes to your emergency fund:
- If you have debt then you should save up a “starter” emergency fund of $1,000 and keep it at that level while you’re paying off your debt; and
- Once you become debt free, you then increase your emergency fund to be able to cover 3-6 months of your living expenses.
That’s what most financial experts will tell you, so I’m sure you’ve heard that before.
Throughout this episode, I’m going to call this the ‘standard approach’ because it’s pretty common advice.
Not all financial experts recommend this approach — myself being one of them, but that’s what you’ll be advised most of the time.
In my brutally honest opinion, it was probably an approach that was put out there by a handful of really popular financial experts like Dave Ramsey.
And then it just gets parroted and repeated over and over and over again by the cult-like following that seems to form around these figures.
Problems with the standard approach
Now, this is often a controversial opinion depending on who I’m talking to, but I absolutely disagree with the standard approach for a number of reasons.
The first major reason being that $1,000 is not enough. It’s clearly designed only to cover emergency expenses like needing a new car battery or fixing the fridge or something like that.
But $1,000 isn’t really going to get you very far these days. It may have at one point in the past, but we’re not living in the past anymore.
A repair that used to cost you $1,000 10 years ago, would cost you about $1,200 now. Why? Because of inflation!
Your starter emergency fund has to keep pace with inflation.
Not only that but $1,000 might not be enough for you if your stuff is always breaking.
Now, I know critics always say, “It's just a guide and you can adjust it for your needs”. But I think that’s crappy advice.
Instead of throwing out a benchmark and telling people to figure it out, they should actually be sharing HOW to figure it out.
So, that’s something we’ll get into a little bit later in this episode.
Another problem I have with the $1,000 starter fund is that it doesn’t prepare you for anything like losing your job.
It doesn’t cover any of your living expenses if you’re out of work or can’t work for whatever reason.
Yes, these experts tell you to build up your emergency fund to cover living expenses, but only after you become debt free.
So, what the hell are you supposed to do if you lose your income before you become debt free?
Whether you get fired, or made redundant or need to leave a toxic environment or if there’s a recession.
What do you do then? Your boss isn’t going to magically give you your job back if you tell them that Dave Ramsey said to have a $1,000 starter emergency fund until you paid off your debt.
Besides, I highly doubt you’re going to be thinking about paying down your debt if you lose your job, and you can’t pay your rent and end up on the street.
You can probably tell, that this makes me really angry! I think it’s really bad advice.
And then let’s say you become debt free and start building your emergency fund to 3-6 months of living expenses.
Is that going to be enough? I would strongly argue that in a lot of cases — it isn’t.
Because a lot of the time when you lose your income, it’s because of something outside your control.
Like the GFC or the COVID pandemic or any other recession. My emergency fund covers at minimum 12 months of my living expenses.
And for the longest time, so many people told me I was crazy! I was wasting my money by keeping so much aside like that.
And then COVID happened. So many people were out of work or saw their incomes drastically reduced.
And suddenly it no longer seemed like a waste to have that much money saved up for an emergency.
Now, once again the critics would tell you to adjust it for your needs but how? I think it’s pretty pointless to say something like that unless they provide you with some kind of framework that you can use to figure it out.
If you’re going to throw out some benchmarks and tell people to just adjust as needed with no advice on how to actually do that — I honestly think you should just not say anything at all.
And that concludes my rant for this episode, so now let’s get to work actually building your emergency fund!
How much should you have in your emergency fund
By now you’re probably thinking, “Well, that’s all well and good Priya, but then how much do you need in your emergency fund?”
So, that’s what I want to tackle in the next part of this episode.
First and foremost, you need to start thinking of your emergency fund as consisting of two distinct parts.
One, is an emergency expenses fund which you’re going to use for things like repairs around your home and car and unexpected medical expenses.
The other part is going to be your income replacement — the living expenses portion.
When you’re trying to determine how much you need to save, you have to consider different things for each of these two parts which is why I like to separate them.
The first part we’re going to cover is saving up for emergency expenses. Basically, the $1,000 part of what some experts will tell you.
This part of the fund needs to cover emergency expenses — and I mean genuine emergencies like things that happened that you could neither predict nor control.
It doesn’t cover things like expenses you forgot to budget for or going over budget with your expenses.
You have control over those things so your forgetfulness or overspending isn’t an emergency.
It does cover things like:
- Repairs for your car or home; and
- Unexpected medical bills or vet bills.
So, when it comes to figuring out how much you need to save to cover those types of emergencies, you need to look at the unique factors at play in your life.
- How old is your car? Does it run pretty well? Is it well maintained? Does it break down or have issues often? Are you a safe driver or do you ding your car around a bit?
- Or, how well maintained is your home? Do you have a security system? Are things falling apart or is it in good shape?
- What about your appliances like the fridge and dishwasher? Are they getting old and starting to have trouble? Do you have leaky pipes? Is your home well ventilated?
You need to ask specific questions like this about your stuff to try and figure out:
- How likely it is that you’re going to need to repair or replace something; and
- How much that repair or replacement will cost.
Is it a big issue or a small one? Are the parts for the repair readily available? Is it something you can fix yourself or will you have to call someone in to do it?
The same kind of logic then applies to any potential medical and vet costs.
Are you generally in good health or do you have some health issues? Are you at risk for bigger health problems down the line?
Are your pets old? Do they get sick often?
So, for me personally most of my stuff is in pretty good condition. We do want to replace our fridge eventually.
There isn’t anything wrong with it but it’s too big for us which means it uses more energy.
And since that kind of replacement isn’t an emergency, we have a sinking fund for it.
We have a dishwasher, washing machine and dryer in our apartment but those appliances came with the apartment which means that as renters, we aren’t responsible for repairing or replacing them.
All our other appliances and electronics like TVs and computers and stuff are all in good shape and we take care of them.
My car is also in pretty good shape. I bought a pre-loved car that was fairly new at the time, she’s only about 11 years old now and doesn’t have a ton of miles on her.
I’m a really safe driver. I’ve never been in any accidents, but other people have hit my poor little car while she’s been parked and I’ve been away.
And I do get a service every now and then and my car has never had any major problems — she runs really well.
Of course, I have to occasionally replace the tires and battery and stuff but I account for that in my car expenses sinking fund.
Because that’s something I can predict, and it’s a common thing, it’s not an emergency.
So, when it comes to repair or replacement of my stuff, I really don’t need a lot saved up.
Now, I do have a bit set aside for unexpected medical expenses. I’ve mentioned before that I have a chronic heart condition.
Most of the time, I just need to pay for my medicine every month which I include in my monthly budget.
I don’t really need additional medical expenses for tests and extra treatments or anything like that.
But I do have some set aside for things like ambulance costs if I happen to have an episode at work and need to get to the hospital. Or if I get into a car accident or something like that.
We do have Medicare in Australia which is our universal healthcare system, and that’s a huge privilege that I know my listeners in the US don’t have.
But even a system like Medicare doesn’t cover everything. For example, I had a little surgery a few years back and it covered that completely.
But I also have to pay out of pocket for cardiologist visits. Any dental will be out of pocket, so are glasses or contact lenses.
So, you really need to think about what you need and what your life is like when you’re trying to save up for emergencies.
And when it comes to figuring out the cost of repairs and replacements — Google it! How much will it cost today?
And then revisit it every year to see whether those costs have increased.
Income replacement / living expenses
The second part of your emergency fund is the income replacement portion, or the living expenses that you should have saved up.
Most financial experts will tell you to save up 3-6 months of essential living expenses.
I don’t think that rule of thumb is good enough because, again, it doesn’t take your personal situation in account.
When saving up for emergency living expenses there are a number of things you need to consider.
First, how much are your living expenses per month? This should include all essentials like rent or mortgage payments, food, utilities, transport.
I know that Dave Ramsey calls this the 4 walls of your house or something like that.
But what about medical costs? And I’m not talking about medical emergencies here, I’m talking about prescriptions, supplements, first aid, birth control.
What about your minimum debt payments? Would your creditors agree to put your debt on hold, or would you be making things worse by missing payments?
You need to think about anything that might be non negotiable for you. Just keep in mind that the higher your monthly essentials are, the more you’ll need to save up.
Your income replacement fund kicks in if you find yourself without your income. So, you’ll need to rely on it if you lose your job for whatever reason or if your hours are cut.
But you’ll also need it if you get fired. Or if you have to walk away from a toxic job where you’re being bullied or harassed or your health is suffering.
Think of it both as a lifeline if you lose your job and as an opportunity to walk away from something that doesn’t serve you.
So, if I don’t believe in the 3-6 months of expenses rule, then what do I recommend?
Well, it depends. Ask yourself this — if you were to lose your job tomorrow, how long would it take for you to replace that income?
That’s how long you should be saving for. And when you try to answer that question there are a bunch of things you need to consider. For example:
- What kind of work do you do? Are your skills easily transferable to other jobs, or are you specialised in one particular area?
- What about the industry you work in? How steady or safe is it? Or, the company you currently work for — are they super steady or are they at risk? Will they withstand a recession or tumble like a house of cards?
- What about the type of job you have? How easy is it to find another job? Is your profession in demand? Are jobs in your field being replaced by outsourcing or technology?
- How recession-proof is your field? Is your job “essential” or is it likely that you’ll be let go during tough times by companies that are trying to keep costs low?
- What are your skills and experience like? What about your education Are you highly marketable? If the market was flooded with thousands of people in your field looking for the same kind of work, how likely are you to stand out?
- Do you have a steady paycheck or are you paid based on commissions Does your income fluctuate from month to month?
- Not only that, but how many people rely on your income? How many people are relying on you earning a steady paycheck? Do you have children to support? Sick partner or elderly parents to take care of?
Do you see what I’m getting at here? Based on the specific work that you do, the industry you work in, your skills, education and experience — how long will it take you to find another job?
One that pays well enough to at least cover your expenses if not totally replace your current income. How long will it take in a recession, to find that kind of job?
What about if you’re self employed or a freelancer? How easy is it for you to ensure recurring, steady income?
Especially during a recession — how easy is it to find a steady stream of paying customers or clients?
What’s the product or service that you provide? Is it an essential that people will continue paying for when they need to cut costs?
Or is it more of a luxury or a “want” that people won’t want to pay for when money is tight?
These are some tough questions and I can’t answer them for you. It’s going to depend on you and your circumstances.
You really need to take the time to think about this instead of following benchmarks.
Because one thing I know for sure is this — the experts who swear by those benchmarks won’t be buying your groceries or paying your rent if you lose your job and end up broke.
Income replacement if you’re married
By now you should have a much clearer understanding of the things you need to consider when planning your emergency fund to cover living expenses.
So, let’s add another layer of complexity to this. You know, just in case it wasn’t already difficult enough.
How much do you need to save for living expenses if you’re married or in a long term relationship where you’re living with your partner?
I’ve heard many experts say that if you’re partnered up, you only need to save half of your living expenses because your partner will cover the other half.
And we’ll get into managing finances with a partner in future episodes because it’s a huge topic on its’ own, but in terms of your emergency fund — that’s terrible advice!
Your basic living expenses should not be dependent entirely on someone else’s income — especially, especially if you’re talking about living expenses in case of an emergency.
What happens during a recession if you and your partner both lose your jobs?
What happens if your partner gets sick and is unable to work and it falls on your shoulders to support your family on a single income?
Or what if your relationship ends? What if you get divorced?
If anything, when you’re married or in a long term relationship, the amount you have to save to cover living expenses should double.
Because there is every chance that one income will need to cover expenses for two people. Or you could both be out of work and your emergency fund runs out twice as fast.
And this is something I say from experience. I’ve spent about 5 years being the sole source of income for my family.
I was stuck in a job I hated, where I was getting bullied every day and treated like crap.
My skills and experience counted for nothing, and my potential was being snuffed out like a candle.
But that job was steady income in an essential business. I earned enough to support my family and still work towards other financial goals.
I had enough saved up to be able to quit and take my time finding another job. But during that time, we wouldn’t have any money coming in.
And what if it took me a long time to find a new job? What if I found one that ended up being so much more horrible and I had no choice but to walk away?
What if that new job wasn’t in an essential industry and I lost my job due to cost cutting? Or my new boss just didn’t like me and I got fired?
Now, I know I could have absolutely quit my toxic job and relied on my emergency fund.
But while I was the sole source of income, I learned just how quickly money runs out when you’re the only one bringing it in.
And yes, my emergency fund would have lasted about 12 months, but I didn’t want to risk a situation where we were both out of work for an extended period of time.
I made the choice to stick it out for as long as I could because the thought of being financially ruined was worse than the situation I was in.
And let me tell you, that’s one of the hardest choices I’ve ever had to make. That job damaged me. My health suffered, my mental health suffered, my marriage suffered.
But I traded all that for the security of sleeping with a roof over my head.
I’ll come back to this story in just a minute but for now, I want to keep moving forward, because this next section will probably help illuminate why I made the choice that I did.
We’ve covered a lot of stuff so far, and if all of this wasn’t complicated enough, I’ve got one more thing I want you to consider when you’re planning out your emergency fund.
How much are you comfortable with? How much is enough to help you sleep at night?
Humans are emotional beings and personal finances are highly personal. That means your emotions, your sense of abundance or scarcity will play a role in the size of your emergency fund.
That’s why even though I had 12 months of living expenses saved up, I chose not to use it and leave a toxic situation that, quite honestly, was slowly killing me.
And I mean that in the most literal sense. I can’t tell you how bad all that stress and anguish was for my heart condition and my health in general.
And I’m not saying that staying in a situation like that for financial stability is a choice that you need to make. But it was the choice I made.
Because I felt like I had no other option. That’s why financial independence is so important to me — I want to have options.
Let’s say you do all the hard work of logically and rationally thinking through all the things we’ve discussed in this podcast so far.
You come up with a number for how much you need to set aside for emergencies.
You look at that number and feel the anxiety building in your stomach. It’s not enough. You don’t feel like you’d be prepared enough.
That’s totally fine — your emergency fund needs to be big enough to help you sleep at night.
You need to make sure that you feel prepared for any emergencies that come around. You need to be confident that you’re going to be able to handle it.
My emergency fund was the very first financial goal that I worked on and that’s the approach that I recommend to my students.
Because if you have no money to feed yourself, then paying off debt and saving for retirement or travelling is the least of your worries.
My parents grew up poor and I grew up hearing those stories. About walking to school with no shoes. Or having to work to support sick parents while being a teenager yourself.
And how important it was for my parents to get a good education, so that they could get a stable job and lift themselves and their parents out of poverty.
Those stories from my parents shaped a lot of my own attitude towards money.
I don’t believe that money will always come to me. That’s why I stayed in such a toxic environment.
And that’s why I made it my #1 priority to become highly skilled and educated in a very stable profession and save up a huge amount for emergencies.
I also have anxiety, sometimes crippling anxiety. And my anxiety in turn makes the symptoms of my heart condition even worse.
My emergency fund at the moment is still enough to cover about 12 months of living expenses.
I have a career in finance. I’m fortunate enough that I’ve never been out of work. I’ve put a lot of time and effort into being really good at what I do.
Even during the COVID pandemic, my skills and experience were highly sought after.
As long as there is money and taxes in the world, I will almost always have a job. Even in a recession or during a global pandemic.
Because honestly, the day that finance professionals are no longer needed in the world is either the day civilisation falls or the robots take over, whichever one comes first.
And my situation is all by design — I did it on purpose. I didn’t dream of a career in finance as a child.
But I knew that I never wanted to have to worry about how I was going to pay the rent.
Or how I was going to feed myself if I ever lost my job.
Because yes, it was by design that my skills and experience are highly marketable.
It was by design that I work in a very stable industry with a very stable income.
But most of the time when you find yourself out of work, it’s entirely outside your control.
The GFC and COVID are complete proof of that. So many people have lost their jobs and even their homes and it had nothing to do with them. It wasn’t their fault.
That’s why it’s so incredibly important that you’re well prepared if ever you find yourself down on your luck.
Building your emergency fund
So, thank you for listening to my interview on the Oprah show!
Now, I wanted to talk a little bit about how to actually save up your emergency fund, now that you know how much you need.
It’s a lot of work — it takes a lot of sacrifice and saying ‘no’ to be able to save up thousands of dollars as quickly as possible.
The first thing you need to do is set a deadline for when you want to finish your emergency fund. This will also depend on how large it is and how much you’re able to set aside.
Let’s just say it’s going to take a year and you’re hoping to save $30,000. That’s $2,500 a month — a pretty ambitious goal, but you’re anxious and you want to get it done because you know how important it is.
Now that you know how much you need to save per month, take a look at your budget and see where you can find the money.
Remember, you may need to make some hard choices and sacrifices to make it work, but it’s not forever.
Do the best that you can, but make sure your budget is still realistic. There’s no point drastically cutting costs if you can’t stick to it.
If you’re still coming up short then you really have only one other option. You need to increase your income.
Start by checking if there’s any way to leverage the income you already make. Can you negotiate a pay increase? Can you take on extra hours or shifts?
Also think about things you have sitting around at home that you might be able to sell.
In the worst case scenario, you’ll need to take on another job. I know it’s not an ideal situation but remember that it’s not forever.
The faster you can build that emergency fund, the faster you can return to your normal budget.
Now, if you ever need to dip into your emergency fund — don’t feel bad. That’s why it’s there.
Just keep in mind that once you dip into your emergency fund, your #1 priority should be to replenish it and top it up as soon as possible.
All other financial goals should be on hold until your emergency fund is fully funded.
Now, keep in mind — putting your other financial goals on hold while you build your emergency fund doesn’t mean that you ignore your debt completely.
You need to continue making your minimum debt payments and keeping on track with that. It just means that you won’t be making extra payments to pay your debts off faster.
That’s really important, so remember that.
It’s also important to remember that your emergency fund isn’t a one and done solution.
You should be revisiting the amount you need to save for emergencies at least once every year.
Go back through all the questions and logic we talked about in this episode.
It’s likely that the amount you need to save will increase a bit every year because of inflation.
Your emergency fund needs to grow over time so that it keeps up with inflation.
But there’s one thing I want to make super clear here — a credit card is not an emergency fund.
I’m going to say that again because you really need to understand this — a credit card is not an emergency fund.
Neither is any type of personal loan or payday loans.
Unless it’s literally a matter of survival, of life and death, you should not be using any kind of debt to cover emergencies.
Why? Well, in an emergency, you’re going to be highly emotional and stressed and anxious.
You’re going to feel a sense of panic, especially if you know that you can’t cover this emergency with your savings.
You’re not always going to be making the best and most rational financial decision. You’re going to be making decisions from that place of emotion and stress.
And that means you could be entering into very predatory lending arrangements.
Or you could wrack up thousands and thousands of dollars of credit card debt that’ll take you years to pay off.
That’s why you need to be prepared with cash for your savings. You want to avoid debt in emergencies as much as possible.
And that’s also why your emergency fund should be your #1 financial goal and why you should aim to have it fully funded as soon as possible.
You won’t be able to become debt free if you’re constantly having to use debt to cover emergencies.
Where should your emergency fund live?
The last topic I wanted to cover today is what to do with your emergency fund once you’ve got it all saved up.
It’s often a pretty large amount of money — tens of thousands of dollars.
So, a lot of people get confused thinking ‘why do I have all that money sitting the bank, why don’t I invest it?’.
Your emergency fund needs to be highly liquid. That means you should be able to access your cash literally at a moments notice.
So, putting your emergency fund in something like a real estate investment is a no-no.
Your emergency could turn from an inconvenience to a hellish nightmare by the time you get your money out.
Or, you’ll be forced to rely on credit cards or payday loans which we just talked about.
You also shouldn’t be investing your emergency fund in the stock market. Yes, you can access your money at least within a few days.
But there’s a lot of volatility in the stock market in the short term. Which means that at any moment, the market could take a nose dive and you could lose all your money.
And then you’re back to lining up for payday loans to cover your emergencies.
The best option is to keep your emergency fund in a HYSA (a high yield savings account).
Your money can just chill out there earning a bit of interest until you need to use it.
Next weeks’ episode
And that’s all I have for you Girls on FIRE today!
I know we’ve gone through a lot today, so take a second to let it all sink in and come back to listen to this episode again if you need to.
On next weeks’ episode we’re going to be discussing the dreaded b-word that makes financial independence possible.
It’s going to be super interesting so you’re definitely not going to want to miss it.