Why an emergency fund and how much time to save for
Most people think it is a good idea to have 3 to 6 months of cash saved in order to protect themselves in case they lose their job. Dave Ramsey recommends 3 months for a stable job industry and 6 months for a less stable industry. I have also read that how many months to save depends on the economy and unemployment rate. According to this recommendation you need to save 3 months in a good economy and 6 months in a bad economy.
I recently got laid off and started thinking about how those calculations were inadequate. Several factors are being ignored in those advices.
- you get unemployment insurance if you are laid off for 6 months. Granted they don’t pay much but in my state it is about the same as earning $15 an hour for the max amount.
- not all jobs take the same amount of time to find. The higher the pay and the more specific a job it is, the more you need to save.
I have an acquaintance who’s husband is a weatherman. This is an extreme example of a high paying, highly specific job. When he got laid off I just hoped that they had saved a ton of money. On the other extreme would be someone laid off from a restaurant, for example. There are plenty of jobs at restaurants.
My way to calculate the size of the emergency fund
One saying that I have heard for years is that “it takes 1 month to find a job for every $10k of job you want”. But I have been hearing that for years. I think we need to adjust for inflation.
According to the cost of living calculator, if that has been said since the early 90s it should now be $20k of salary per month.
So if you are looking for a $60k job it should take 3 months on average to find a job. This is back to the original recommendation. However, that is the average which means that for every person who finds job right away and there will be someone who will find it in 6 months. So, we are back to 6 months for the average job.
If you are looking for a higher paid job, like a $100,000 job that would be:
$100,000 divided by $20,000 per month = 5 months x 2 for the worst case range = 10 months.
If you are living on $100k right now you especially need to save all that because unemployment will be a drop in the bucket.
How to calculate how much to save in dollars
You can add up all your expenses and multiply by the number of months you have to save or you can multiply your monthly take home pay by that amount, Or for a quick calc you can just take 25% of your annual salary, divide by 12 and multiply by the number of months you need.
Make sure to keep that savings in cash so you don’t run up costly credit cards avoiding selling your investments. I made that mistake already!