This simple formula could mean all the difference in an emergency.
Posted by Catherine New on August 6th, 2013 | 1 Comment /
KEY TAKEAWAYS
An emergency fund should contain enough money to cover your basic expenses for a minimum of several months.
A simple formula: Monthly expenditures * Re-employment period = Baseline safety net amount
Here’s the bottom line: Learn more about Betterment
A fundamental of good personal finance is to have a backup plan in place — or a stash of money that will buffer you against the bigger knocks in life, like losing a source of income for a period of time. This should be a somewhat liquid account that you can access on a few days’ notice.
But how much do you actually need to set aside in a sound safety net fund? Much of that depends on how much you spend on essential costs each month. There is no perfect answer, but here’s a rough guide that you can modify as is appropriate for your circumstances.
What are your essential costs?
Ideally, you should have an estimate for the smallest amount you’d be able to live on month-to-month. That includes housing, food, clothing, transportation, health insurance, and essential liabilities (utilities, loan payments, etc.,) Add those up to get the sum of your monthly expenditure.
You also need an idea of how long you might be without income. In this case you can multiply your monthly minimum spend by your re-employment period (the number of months it might take you to find a new job.) According to the most recent July 2013 data from the Bureau of Labor Statistics, the average duration for unemployment in the United States was was 37 weeks. That could be less depending on your industry and skills. As another ballpark, it is a good idea to have a minimum of four to six months of expenses covered in your safety net fund.
Here’s a simple formula to get you started:
Monthly expenditures * Re-employment period = Baseline safety net amount
If you can fully fund your baseline safety net, Betterment’s Director of Investing and Behavioral Finance Dan Egan explained in a recent blog post why you might consider creating a safety net fund that is even larger than this amount — and investing that money.
For those who have not yet saved for a safety net fund, Betterment’s advice can tell you exactly how much you need to save every month to meet your target over the next three to five years. For example, if your goal is to save $20,000 in three years for a safety net, Betterment suggests a monthly deposit of $521.86 to get you there.¹
To be sure, you should always keep a small reserve of cash on hand for immediate emergencies. But if you plan to keep a safety net fund in place for the long term, investing might be a smarter choice as cash will likely lose its value due to inflation.
¹Suggested monthly deposit based on Betterment’s default safety net advice with zero initial deposit, which recommends an asset allocation of 40 percent stocks. Returns are subject to the disclosure found here.
via Funding A Safety Net: Calculate Your Target Amount – Betterment.
