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You may have heard of the concept of keeping an emergency fund, but for those new to the term, an emergency fund is money set aside to be used only in the case of a life emergency. A financial emergency is an unexpected and required event that you’re unable to pay for with your regular monthly income. Think of it as a small self-insurance policy. And no, a last minute vacation to Vegas, although pretty awesome, isn’t an emergency! Below are six major points to think about in relation to your emergency fund.3-6 months as the Rule of Thumb
1. Use 3-6 Months as a Rule of Thumb
Most finance experts will tell you that you need between 3 to 6 months of expenses in liquid savings (i.e. cash). This figure is used because for the typical family that’s enough to help you get by if you ever happen to lose your job, not to mention helping you cover unexpected bills, car repairs, etc.
2. Know Your Monthly Expenses
If you’re going to use the 3-6 months expenses rule, you’ll need to determine what that is. The quickest way to do that is to get online and view the last 6 months of transactions from you bank, paying particular attention to regular expenses.
3. Know Your Assets
For example, if you’re a one car family, unless you live in the city, you are highly dependent on that car (asset). If that car needed a £2,500 repair, you’d have no choice but to spend the money to repair it. Likewise, if your home is in need of constant repair, your emergency fund will need to trend higher to be able to cover those repairs.
4. Know Your Job Market
Are you the sole bread-winner in the family and if so, are you confident that you could get another job a few weeks or months after you’ve been laid off? However, if you think it would take more than a few months, because (a) your industry is in bad shape, or (b) you aren’t that marketable (for whatever reason), then consider bumping your emergency fund number up above the six month mark and keep going until you feel comfortable with the number.
If you start with the three month rule and then bump that up based on the risk involved in the areas I listed above, you can get pretty close to your actual required emergency fund. However, when in doubt, just strive to make your emergency fund big enough to cover you for 3-6 months of income instead of expenses. That’s a very conservative number and would put you way ahead of most other savers.
What strategy are you currently using to finance your emergency fund?
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