Emergency Funds The Easy Way: Benchmarks for Saving
In the world of personal finance, one term that's thrown around is the "emergency fund." We've all heard the standard advice: save up three to eight months' worth of expenses to have a fully funded emergency fund to cope with the curveballs life throws. As a financial therapist and former researcher, I got curious about where that number came from, and on the way, I found out that there is some new evidence about how much money we actually need in an emergency fund.
The good news? This new way of saving up for an emergency fund requires way less calculations and feels much less daunting, too.
The Origins of the Three to Eight-Month Rule
Everywhere I looked (aka Google and in all of the personal finance books I own), it seemed like the same guideline was repeated. “A fully funded emergency fund is 3-8 months of expenses.” But that guideline has been repeated for years without much evidence to back it up.
At one point in time, the fuzzy explanation for it was that it takes six to eight months to find a new job if you were laid off. (AKA you’d need 6-8 months of expenses to make sure you were ok financially if you weren’t earning money). But, from what I could find? This data is at least 15 years old, going back to the time of The Great Recession.
It's worth noting that The Great Recession marked one of the longest periods of unemployment for many individuals. In other words? It’s time to revisit the dusty rule that we need an 8-month emergency fund!
Importance of The Emergency Fund
Before we get into my basically no-calculation emergency fund, let's clarify what an emergency fund is. It's cash kept in a savings account, preferably a high-yield one (HYSA), that you can access in an emergency. This savings account should be insured through the FDIC or NCUA.
An emergency fund is a financial safety net that prevents you from falling into a deeper hole if you are in a financial pickle. You can use your emergency savings cash instead of putting expenses on a high-interest credit card or borrowing money from a predatory lender, like a payday loan lender.
An emergency fund is for genuine emergencies, such as being unable to work for a week because you have to care for a family member or needing to pay to replace food in your refrigerator after an extended power outage. As tempting as it might be, an emergency fund is not for impulse purchases like a flash sale at your favorite retailer or travel website.
This fund is also important if you have debt. It can be tempting to pay off as much debt as possible before saving up for an emergency, but without an emergency fund, it’s too easy to keep adding expenses to credit cards. And those credit cards often have some hefty interest rates, so the more you can avoid that, the better!
Rule of Thumb: New Data-Driven Savings Research
In 2019, researchers Jorge Sabat and Emily Gallagher took a data-driven approach to provide a more accurate benchmark for emergency savings. Focusing on individuals with lower incomes, they sought “the minimum liquidity buffer needed by the average low-income household.” In non-research speak, this means they wanted to figure out how much cash was needed to prevent a one-time financial hardship from becoming a financial disaster.
The number they landed on? $2,467 (as of 2023, this number is $2,970 when adjusted for inflation). They found that for most people, this amount of money is enough to cover a big unexpected expense AND be able to cover other bills. If that $2,467 feels out of reach, starting with $500 is great. Sabat and Gallagher found that each additional dollar saved past $500 significantly reduces the risk of long-term financial disaster.
To summarize their example:
If a family faces a $1,000 unexpected expense, like a health care deductible, with only $100 in savings, they might not be able to pay their medical bill and might also skip other bills (like electricity, rent, etc.). This is more expensive –financially and emotionally–than facing the same expense with $900 saved, which might only result in one late bill payment.
Mind Money Balance’s Benchmark Savings Goals
While no savings is easy, this is an easy savings plan compared to the daunting task of saving up for 8-months of expenses! With this new data, we can create three (much more) achievable savings goals for your emergency fund.
New Emergency Fund Goal
$400
$1,000
$2,467 (or the inflation-adjusted number that Sabat & Gallagher found in their research)
Why these financial benchmarks? In 2020, about a quarter of Americans had less than $400 available for emergencies. Moving beyond this $400 is the first step toward financial safety. The next number to aim for, $1,000, is more of a psychological milestone. In my financial therapy practice, I’ve noticed that when clients have a four-digit emergency fund, it can instill a sense of financial security and increase their confidence. The final savings goal should be $2,467 but adjusted for inflation. As of 2023, the updated benchmark is $2,970 (adjust this figure for inflation each year by visiting this easy calculator website).
Beyond Benchmarks: Tailoring to Your Needs
If these numbers don’t provide you with enough safety, or you have unique needs requiring a larger financial safety net, full permission to save more! The beautiful thing about personal finances is that you can tailor most tools to meet your needs.
To cover more of your living expenses beyond the recommended amount from Sabat & Gallagher, average your monthly expenses over the past three months. Then, remove anything unnecessary, such as dining out or going to the movies. This number is now your “one-month” emergency savings goal. If you want a three-month fund, multiply by 3; if you want a four-month fund, multiply by 4, and so on.
What Else Can I Call My Emergency Fund?
If the term “emergency fund” isn’t resonating, permission to rename it! If you’re new here, I don’t love the word “budget” and prefer to call it a “spending plan.” Some of my financial therapy clients feel like calling their savings account an emergency fund is “beckoning an emergency to happen!”
Other terms I’ve heard used for an emergency fund include:
Life Happens Fund
FU Money
Contingency Money
Peace of Mind Fund
Energy Replenishment
Nest Egg
Rainy Day Money
Stockpile Cash
Reserve Money
Plan B
Emergency Fund Benefit: Financial Peace & Security
The good news is that the new fully funded emergency emergency fund formula is way easier to calculate and save up for. An emergency fund is a powerful tool to keep us financially and emotionally safe when life happens. Saving up $400 and increasing it to $2,467 is a great financial benchmark (and data-driven, too!).
If this article and video helped you feel better about your emergency fund goals, imagine the impact of sharing this knowledge on your organization or community! By inviting a seasoned speaker and financial therapist like myself to share insights and strategies for building data-driven financial foundations, you can empower individuals to take meaningful steps toward a healthy relationship with money. Inquire here about bringing me in for a workshop, presentation or keynote today!