Is It Six Months Of Paychecks?
Steve asks when it's time to save his fully funded emergency fund, is it his whole paycheck for six months or his bills for six months?
QUESTION: Steve on Facebook asks when it’s time to save his fully funded emergency fund, is it his whole paycheck for six months or his bills for six months?
ANSWER: Your paycheck is not your expenses unless you spend your whole paycheck, so it’s six months of expenses. What are your expenses? It would be your bills total, including your food and that kind of thing. What does it take to operate for six months if you suddenly had no income? Hopefully, if you’ve gotten to that point, you’re not spending all of your income anymore, so six months of expenses would be less than six months of pay, I hope. A properly done emergency fund is three to six months of household expenses set aside to never be touched for any reason except for an emergency. It’s not a couch fund. It’s not a “I want to go to the Bahamas fishing” fund. It’s an emergency fund, and it’s not an investment—it’s insurance. Investments make you money. Insurance costs you money to protect the things that make you money. When you set $10,000 or $15,000 or whatever that three to six months of expenses represents aside in a simple money market account, it’s not making you any money. It’s just parked there. The purpose is not to make money with it. The purpose is to protect you so you don’t have to cash out the things that are making money, like a 401(k), or you don’t end up going into debt or something like that when your transmission goes out—and it will.
How do I decide if I’m on the three months side or the six months side of that? The more risk your household has, you would go to the six months side. If there’s only one income for two of you, you have more risk and you might skew toward the six months side. If you’re self-employed, you might skew toward the six months side. If you’re a commissioned salesperson, you might skew toward the six months side. If both of you are government workers, one of you is a postal worker and the other is a teacher, two incomes, both from very steady sources, you could skew back toward the three months side. Where the household has less risk, we can skew toward the three months side.