How Much Emergency Fund Do You Need?
The money kept aside for unexpected expenses or a fall in income is called an emergency fund. The amount you need depends on your essential expenses, how stable your income is and what your household has to cover, and it is counted in months of spending.
If a large, unexpected expense turned up tomorrow, or your income fell for a few months, where would the money come from? Without a reserve, the answer is often a credit card, a loan or selling investments, sometimes at a bad moment.
That question is what an emergency fund is for. As a reference, people often talk about three to six months of essential expenses. It is a starting point to adjust to each case: there is no right number for everyone.
What it is for, and what it is not for
An emergency can be an unexpected expense that cannot wait, or a drop in income. Think of a breakdown, an urgent repair at home, a health expense or a few months without work.
Expenses you already know about stay out, even when they are large or come once a year: scheduled car servicing, annual insurance, holidays, the deposit on a home. They belong in the budget or in savings of their own, and some of them are goals, with a deadline and an amount, as explained in “How to Make a Goal-Based Financial Plan”. Paid from the fund, they leave it with no money for what nobody saw coming.
How to calculate the amount you need
The calculation takes three steps.
The calculation in three steps
1. A month of essential expenses
Add up the expenses that would still have to be paid in a difficult month and leave out the ones you could do without. This is not the same as splitting fixed from variable costs: food varies and is essential; a subscription is fixed and can be cancelled. As a rule, the list includes housing, food, household bills, transport, health and loan repayments.
Your bank statements for the last three to six months help you estimate your current essential expenses. Essential yearly expenses, such as insurance or property tax, count as the yearly total divided by twelve. If they already show up in the statements, adjust the figures so that they are counted only once, at that monthly amount.
2. How many months of cover
The number of months depends mostly on how likely you are to lose your income, or part of it, and on how long it would take to get it back. The table brings together factors that tend to matter. Treat it as a guide: none of them sets a number of months on its own, and what counts is the overall picture.
| A smaller reserve may be enough | A larger reserve may be justified |
|---|---|
| A stable employment contract | A fixed-term contract, self-employment or a variable income |
| Two incomes in the household, from different employers and sectors | A single income, or two that depend on the same employer or the same sector |
| Nobody depending on you financially | Children or other people who rely on that income |
| A profession where new work comes quickly | A field where changing jobs takes time |
| Insurance that covers the main risks | A higher chance of unexpected costs on the home or the car, for example because they are older |
A variable income, common when you work for yourself, may justify a wider margin. How deep and how long the leaner periods of recent years were helps you size that margin.
3. Multiply
The fund is your essential expenses multiplied by the months of cover.
An example. A family with 1,400 € of essential expenses a month:
1,400 € × 3 months = 4,200 €
1,400 € × 6 months = 8,400 €
With the same three steps, another family arrives at a different number.
Where to keep an emergency fund
The right place meets three requirements:
- availability: the money can be used when it is needed;
- capital preservation: the amount in euros you can take out is the amount you put aside;
- separation: it is kept apart from your everyday money; when money has a clear job, it is easier to leave it alone.
Available does not always mean the same thing. Part of the reserve may have to be reachable immediately, for a repair or a health expense. For the rest, check that the time it takes to get the money still lets you pay the bills when they are due.
That is why the reserve usually sits in a current or savings account, or in a term deposit that lets you take the money out before it ends. With deposits, read what the contract says about early withdrawal and what it costs: some can be withdrawn before the term, giving up interest, and others cannot.
Interest helps, but it is weighed together with availability and capital preservation. And keeping the same number of euros is not the same as keeping purchasing power: if the interest, after tax, stays below inflation, the money buys less without having lost any nominal value.
Products whose value goes up and down, such as shares and equity ETFs or funds, are a poor fit for this job: when you need the money, it may be worth less than you put in. Not every fund moves in the same way; with any product, check how much its value can change and how long it takes for the money to reach you.
Then there is the long-term plan. A recession can bring fewer jobs and falling markets at the same time, and selling investments at that point takes money out of the plan while prices are low, which can put it at risk. The reserve makes you less dependent on such sales. It is a question of your capacity to take risk, not only your willingness, as explained in “Understanding Your Risk Tolerance”.
How to build the fund, step by step
Few people can set aside six months of expenses in one go, and there is no need to start there. A common route:
- start with a smaller target, such as one month of essential expenses;
- set up an automatic transfer for the day your salary arrives, so the saving happens before the spending;
- use one-off income, such as holiday or Christmas bonuses or a tax refund, to get there faster.
After using the fund, see how much is missing and adjust your next savings to refill it, keeping your other financial commitments in mind. Rebuilding the reserve can take priority over some goals, without putting all of them on hold.
When to review the amount
The fund is sized for the life you have today, and it changes when your life does: a child, a new home or a higher mortgage payment, a change of job, starting to work for yourself. Expenses also rise with inflation, and an amount that was enough three years ago may not be enough now. A review once a year, or at every big change, keeps the reserve in line with your situation.
The first step before investing
With the reserve in place, the money you invest does not have to cover emergencies, and the long-term plan is less exposed to forced sales. On the role of time, see “Rolling Returns: Why the Start Date Matters”.
At PortfolYou, the Lifetime Balance Sheet compares the money you hold in accounts and cash with your monthly spending, estimated from your total yearly spending. It shows a warning when that amount covers less than three months of expenses. Investments are not part of the calculation. Even so, the money in your accounts may include savings for other goals: only the part set aside for emergencies is your emergency fund.