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How Much Should You Hold in Emergency Savings?

dollar bill flippingAlthough saving for the long-term future is important, you should also consider holding some share of your money in cash and similar short-term investments (sometimes called cash equivalents) such as CDs, money market funds, and short-term treasuries.

The logic is fairly simple: If an emergency pops up, you don’t want to have to liquidate long-term investments such as retirement accounts or college savings accounts.

The right amount of emergency savings will be different for everyone based on a variety of factors:

  • How secure is your job? For people with less job security, a higher emergency savings fund may be wise.
  • Does your household have one or two incomes? For one-earner households, it will be more important to keep a larger emergency stash.
  • Do you have other possible sources of income? People who rely on jobs for all of their income may consider keeping more in the emergency fund.
  • How is your health? People with potential health concerns may consider setting more aside.
  • Who relies on your income? Children and parents that may need help could encourage you to keep more in a safety fund.

One strategy for figuring out how much you should keep in your emergency fund is to compare your total liquid assets (money that is readily available such as cash) against your total current debts, including annual loan payments.

For example, if you have $5,000 in credit card debt and your mortgage, car, and student loans will cost $25,000 over the next year, you have $30,000 in current debts. A rule of thumb is to maintain somewhere between one and two times as much in emergency assets. This means that you’d keep $30,000 to $60,000 in liquid assets. Again, some people will be comfortable with less if their circumstances are stable, whereas others may want additional security.

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One Comment Post a comment
  1. Gilbert W. Chapman #

    My rule of thumb, when my wife I first got out of college back in the seventies, was to keep six months of net income (after taxes, 401k contributions) in liquid assets . . . We both always earned about the same, and I always felt it would be ‘super crisis’ (Black Swan Event) if we both lost our jobs simultaneously, so that figure would have ‘protected’ us for a year. (I believe that if you can’t find a job in a year you aren’t really looking, regardless of what the pundits say today.)

    By example, back then we both earned about $25,000 annually, which meant I always kept about $15,000 to $20,000 in reserve, and kept on increasing the amount as our salaries went up.

    Now that we are in retirement I keep about two years of projected 401k liquidations (3% x 2) in reserve . . . And I assume that cash flow from Social Security and annuities is fixed.

    In other words if someone is liquidating $30,000 annually (3%) from a $1,000,000 401k portfolio, keep $60,000 in liquid assets . . . That way, if there is a stock market ‘crash’, as happened in 2008/2009, there is no need to sell equities during a down market. Additionally one can defer some capital expenditures (new roof on your home), new car, trip to Europe, whatever.

    By the way . . . I retired in October of 2007 . . . And my idea worked . . . “Never get yourself into a position where you have have to liquidate equities (mutual funds in my case) during a Bear Market.”

    Liked by 1 person

    December 23, 2015

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