How much money to keep as your emergency funds is another one of those questions where the answer will frustrate many. Because the answer starts with “it depends…”
Nobody knows for sure what the future holds. This is why even veteran and savvy investors keep a healthy cash reserve in cash of emergency situations. The pragmatic way to plan for the unexpected is to anticipate situations where you need money instead of situations where you receive a financial windfall.
The problem with emergency cash is that almost every individual will have their own legitimate idea of how much is enough. This is because each person have their own different financial commitments, income and lifestyle. There cannot be a hard and fast rule unless we take into account an individual’s personal lifestyle and income. Even then, it will be a long shot to declare that a certain ratio will work for everyone.
What we can say for certain is that the higher the income, the more luxurious someone tends to live. So lifestyle expenses could be a good start at a measuring point.
The 3 emergency cash brackets
1) 3 months living expenses. This is a comfortable bracket to fall into when you have other investments or assets that are liquid. If you do not have adverse credit, you will be able to get short term loans from lenders as well. 3 months worth of living expenses is the bare minimum when you are confident that your other assets can dig you out of a hole as long as you have enough time to liquidate them.
2) 6 months living expenses. You want to keep this amount available in your account when you have no lenders to turn to for quick cash. You also want to have this amount available to draw upon when you do not have stability in your job or income. Even if you have a house which you are willing to let go of, it takes time for the house to sell and for the cash to come in.
3) 12 months living expenses. You want to keep this amount in your emergency account if your personal income fluctuates with high volatility each year. Many startup business owners fall into this category when the business has yet to stabilize. A business can go for years operating at a loss and explode into profits suddenly. The drawback is that you must have a bigger cash reserve in case things go south.
Finally, avoid depending on your credit cards when planning your emergency cash positions. They can be unpredictable and charge high interest rates as well. The last thing you want during an emergency is to go deep into debt just to stay afloat.