Your Emergency Fund: How Much Is Enough?

As much as we’d all like to, it’s impossible to stop adverse events such as job loss or sickness. If you don’t have the cash to cover an emergency, you’re taking a big risk.

You don’t want to find yourself in need of cash you don’t have, which is why you must have an emergency fund. While it can be hard to figure out how large that fund should be, this article aims to help you decide how much to save in case bad luck hits.

What’s the right amount to set aside?
It’s impossible to know how much an emergency will cost you, but it’s better to be over-prepared than under-prepared. Typically, it is advisable that your emergency fund contain enough money for you to live for about three to six months.  

This should be calculated based on essential expenses you’d keep paying in times of hardship. Have enough to pay for housing costs, food, utilities, insurance, transport, debt payments, and personal expenses. You don’t necessarily need to save enough to ensure you can keep eating out twice a week or to cover other entertainment expenses. The must-pay expenses are what matter.

An emergency fund with three to six months of living expenses could sustain you if you suffer a serious medical issue, can’t work for a while, and aren’t eligible for disability benefits. Or, if you were to be deemed redundant by your employer, it could give you the money to keep making mortgage payments until you find your next job.

In other words, it could mean the difference between a brief period of financial hardship and long-term financial disaster.

How should you decide whether to save three months or six months of living expenses?
There’s a rather huge difference between saving three months of living expenses and saving six months of living expenses – so what size of an emergency fund is right for you? The answer depends on how vulnerable you are to a financial emergency.

Your emergency fund should be more substantial if:

  • You’re the sole or main breadwinner
  • You have an unstable job
  • It would take you a long time to find a new job if you lost your current position
  • You have no other money saved for home or car repairs
  • You aren’t very healthy

The likelier it is that you’ll lose your sources of income or need lots of money to pay surprise expenses, the bigger your emergency fund should be.

When does a smaller emergency fund make sense?
While saving three to six months of living expenses in an emergency fund is a good rule of thumb, it takes a lot of time and financial discipline to put aside this much money. And, there is one situation where you may not want to set this big goal right away: when you have a lot of debt.

If you owe a lot of money, you still need to prioritize building up an emergency fund before paying extra toward debt. If you don’t, you can’t break the debt cycle. While extra payments could help reduce your debt balance, a single bit of bad luck would lead you to accumulate debt on your credit cards again. This creates a never-ending cycle where you don’t make progress – and there’s a big risk that you’ll give up on aggressive debt repayment.

To avoid this problem, save up a mini emergency fund, then switch to bigger debt payments. The amount of your mini emergency fund will also be determined based on your personal situation. Saving $2,000 to $3,000 is a good rule of thumb, and you should aim for a larger amount if income is uncertain or there’s reason to believe you’re at high risk of costly emergencies.

When your mini emergency fund is built up, shift focus to paying your debt – although if you spend your fund, go back to building it up again. After debt is paid down, finish saving enough so your emergency fund covers the recommended three to six months of expenses.

Money Advice that Don’t Grow Old

Personal finances2

Many recommendations I’ve made are as applicable today as they will be in future, and they bear repeating. Here are some of the best financial moves for you to consider:

1. Understanding and managing your thoughts, feelings, and beliefs about money is as important as understanding how money works. Our brains are programmed to make poor financial decisions. Exploring your money history and learning to identify your unconscious beliefs about money can change your financial behaviours forever. It is important to gain control of your finances and become comfortable using money as the valuable tool it is.

2. Building an emergency reserve to cover living expenses for three to months if you lose your job or experience a business slump is a necessity. If you are retired, having one to three years of cash available to cover living expenses can help you avoid taking money out of investments when their value has declined.

3. Retirement will happen, sooner than you think. Start early — as in the day after university graduation — and be consistent in investing at least 20 percent of your paycheck.

4. Learn to appreciate the word “budget”. Creating a way to track and manage income and expenses is an essential skill to thrive financially. Numerous free or inexpensive tools, like Mint.com and Expensify, can help.

5. Run from consumer debt. Personally, I use credit cards for almost every purchase for convenience and cash back rewards. However, it’s of vital importance to pay the card off every month, without fail.

6. A house is a home, not an investment. Don’t buy more home than you can afford, and don’t buy without a down payment.

7. No asset goes up forever. Price declines, even crashes, are part and parcel of investing. It’s essential to understand that the value of your portfolio will fluctuate. Be prepared to ride out downturns. Selling in a down market is a big mistake that will cost you dearly.

8. The fundamental strategy for managing market ups and downs is asset class diversification. This doesn’t mean having money in different banks, with different brokers, or with different fund managers. It’s about having a good balance of mutual/exchange-traded funds that invest in SG and International stocks, SG and International government bonds, real estate investment trusts, commodities and junk bonds.

9. There are no free investments. Pay attention to the fees associated with any investment, as well as how the advisor recommending any investment is compensated.

10. Pay yourself first. The most successful savers and investors I know simply take all their fixed expenses, taxes, and retirement plan contributions off their income earned, then spend the rest. This means learning to live on 30% to 50% of how much you earn. Certainly, it isn’t easy, but one of the most valuable money habits to cultivate is to save something for the future, instead of spending everything that comes in.

You may have likely heard of these pieces of advice before. There’s a reason for that: it works, and never goes out of style.

Manage Your Wealth Like a Football Team

Just like managing a football team, managing your wealth properly requires a good team of players in 3 departments – defence, midfield and forwards.

In a game of football, let’s imagine if we have a team with a great goalkeeper and defenders but without strong forwards, will we be able to win? Well, the best possible result may perhaps be just a draw. In reality, when it comes to managing wealth, many people have made the mistake of being too conservative.

footballA dangerous thought which they have is keeping all of their savings in their bank accounts, assuming it is the most reliable way to make their money grow. However, they have forgotten the fact that bank interest rates can never keep up with the pace of inflation. Over a long period, the savings of these people will diminish in terms of purchasing power.

On another hand, can a football team do without a dependable goalkeeper and defence? The answer is certainly no. When facing the fierce attacks of an opponent, a team with a weak defence will be in shambles and suffer terribly. Similarly, without proper insurance cover to protect our wealth, if any disaster strikes, a rich man can very quickly become a poor man. Therefore, just like managing a football team, managing your wealth properly requires a good team of players in 3 departments – defence, midfield and forwards. With this analogy, let’s look at these 3 departments in wealth management.

1. Defence: Emergency Fund & Insurance

As the saying “Saving for a rainy day” goes, we should aim to keep an emergency fund of 3 to 6 times of our monthly expenses. This sum of cash will come in handy when events like a salary cut or retrenchment happens. For this emergency fund, we can save our money in bank savings accounts, fixed deposits or money market funds.

At the same time, we should also purchase insurance. For instance, hospitalisation insurance covers your medical bills in case of an accident or critical illness. Surgical fees can amount to over tens of thousands of dollars, and treatment for long-term illnesses such as kidney dialysis can cost more than $20,000 annually. With adequate protection, it gives you a peace of mind that unforeseen circumstances are prepared for. To understand your insurance needs, you can refer to an earlier post here.

2. Midfield: Endowment and Moderate Risk Investments for the Mid-Term

A strong midfielder has to be able to support the forwards and help out in defence. You can think of putting your money in investment instruments with moderate risks, such as savings endowment policies and balanced funds which invests in a mix of fixed-income (bonds) and equity, some with a larger portion in bonds. Alternatively, you can set aside a pre-determined amount to invest every month in global funds. This strategy of dollar cost averaging can help your money grow in the mid-term.

3. Forwards: High Yield Investments

With a solid defence and reliable midfield, if you have a surplus of cash and wish to grow it, you can put your money in investments with high returns and high risks. Such investments include real estate, stocks, currencies or sector funds. For those of you who actively keeps an eye on the stock market, you should have a super-sub forward – an opportunity fund. Every crisis comes with an opportunity. Whenever there is a global stock market recession, we are presented with an opportunity to buy stocks at very low prices, like it were the Great Singapore Sale. If you had bought DBS shares in early 2009 when the price was $7 per share, you can sell them off at $16 per share now and earn a huge profit.

Here’s to your financial success by managing your money just like a football team, or for the matter, any other team sports which requires a defence, midfield and forwards.