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You are here: Home / Podcast Episodes / How Much You Should Have In An Emergency Fund – MPSOS108 [podcast]

How Much You Should Have In An Emergency Fund – MPSOS108 [podcast]

By Steve Stewart on May 9, 2013

How Much You Should Have In An Emergency Fund – MPSOS108 [podcast]

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  • How Much You Should Have In An Emergency Fund – MPSOS108 [podcast]
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You need an emergency fund in case of an emergencyDo you know how much you should have in an Emergency Fund? Dave Ramsey recommends having a 3 to 6 month worth of liquid savings in case the unthinkable were to happen. Serious illness, sudden loss of income, or expensive unpredictable events can take anyone by surprise. Having thousands of dollars in savings could convert a horrible tragedy into the equivalent of a “bad hair day”.

Emergency Fund Expenses, not Operating Capital

We budget more than $6,000 every month. To me, that’s a lot of money! But if you could see where it all goes then you would understand. Some of our budgeted money goes towards car replacement and our daughter’s first car/college/wedding (in that order please). We’ve also committed to give extra to our church for a new building campaign.

If we were to keep 3-6 months worth of “operating capital” in the bank it would be equal to $20,000 – $40,000. There is nothing wrong with saving that much money except the opportunity cost of the excess cash that probably isn’t necessary for an emergency fund. Also, keeping too much money in a low interest-bearing savings account loses purchasing power as the value decreases due to inflation. This is the main reason why an emergency fund is factored only on needs, not lifestyle or average monthly income.

What emergency funds are for

While the Stewart household operates on more than $6,000 a month, it’s not what our emergency fund is based on. Take away some of the “niceties” and pleasures of life and a typical month’s needs turns into approximately $3,800. I use the word “approximately” because we can’t predict the actual number. Emergencies of all kinds come in many shapes and sizes:

  • An injury increases medical expenses but does not lower other monthly expenses like groceries or electricity
  • A job loss decreases a tithe and will increase job-hunt related expenses like gasoline and copies of your resume’ at Office Depot
  • Replacing a wrecked car will deplete an emergency fund but won’t change normal monthly operating expenses

Having cash at-the-ready makes all of these situations much easier to handle and I sleep better because I know it’s there.

What is included in calculating Emergency Funds

For us to estimate the correct amount needed in an emergency situation, such as me or my wife losing our day-job, I have to cut out all the “niceties” like saving for my daughter’s future or my Roth IRA. I would have to drastically slash things like the entertainment and clothing budget categories and would probably drop our cable package down to internet-only. The idea is to get expenses down to make emergency funds last as long as possible.

Three months of our operating capital comes out to be more than $20,000 and six months is more than $40,000! However, taking out all the fluff makes our true need for emergency fund to be $11,000 – $23,000. That’s much better!

Include these necessities when calculating 3-6 months expenses

  • Shelter (rent or mortgage)
  • Utilities (heat and lights)
  • Food (like groceries, not eating out)
  • Transportation (gasoline and car payment)
  • Insurance (car, health, life)
  • Clothing

If you take a look at your budget then you can find some things to cut now. For example: I would love to get rid of our cable now but my wife won’t let me.

If you don’t have a budget then listen to http://MoneyPlanSOS.com/5 to learn how to create the Absolute Simplest Budget That Works.

Emergencies are better without debt

It should come as no surprise that a job loss or sudden expense isn’t as tragic when you don’t have to debt payments to service.

  • An American couple that pays cash for their cars or pays them off will reduce their Emergency Fund need by as much as $1,100 a month (based on an average car payment of $550 according to the 2013 Car Affordability Study)
  • Eliminate credit card debt from your life and you could increase monthly cash flow $632 (average household credit card debt $15,700)
  • A quick search on Twitter revealed Tweeps are paying between $250 – $800 in student loan payments

If this is you then you are strangling your checkbook’s cash flow with over $2,000 in debt payments every single month. OUCH!

Note: I don’t recommend having a fully-funded emergency fund when paying off non-mortgage debt. Save $1,000 for the little bumps in the road so you can attack your debt quickly, then save up the rest after the last debt is gone!

Using an emergency fund for a non-emergency?

In Dave Ramsey’s world, this sounds like blasphemy! Don’t touch an emergency fund for anything but emergencies! I agree completely! It would be irresponsible of me to take my family’s emergency fund down to less than 3-6 months of expenses.

What if I told you there’s a way to take money out of your emergency fund and pay off your house without breaking the rules? Here is how we will dip into our 3-6 month emergency fund to pay off the house without leaving ourselves with less than 3-6 months of expenses in the account:

My wife and I have less than 3 years left on our mortgage. If our current emergency fund calculation is $23,000 for 6 months with a house payment then what would it need to be when the mortgage has been paid off? The answer: $16,000.

If our emergency fund needs to be $16,000 without a house payment but we have $23,000 saved and $7,000 left on our mortgage then why not knock it out now?

It sounds like a trick but it’s legit

We have to re-evaluate our emergency fund every year anyway because of changes in household expenses and family needs. This way we get to PAY OFF THE HOUSE SOONER and not put our family in any additional risk. We get to be 100% debt free with a fully funded emergency fund by paying attention and we will no longer be paying interest.

Please leave your comments and suggestions for in the comments below.

Reader Interactions

Comments

  1. MrJoshuaBrown says

    May 9, 2013 at 6:51 pm

    We have figured between $9000-18000 would be the amount we needed in our emergency fund.  My wife decided that she wanted $10,000 so that is the number have used because I want to make sure that “security gland” Dave talks about is taken care of.

  2. SparingChange says

    May 16, 2013 at 5:18 am

    We have had $6,000 in our Emergency Fund for a couple years now, but your podcast got me thinking.  So, I had to do the numbers. 🙂  Because we have a mortgage, we should have $4500-$9000 in our EF.  When the mortgage is paid off (end of 2014), we should have $3300-$6600.  As you can tell, our monthly living expenses are pretty slim, and I like it like that! 🙂  We have worked hard over the past several years to make it this way.

  3. Tamara says

    August 4, 2014 at 9:31 am

    I once had $10k in an emergency fund. It stood there for the longest time, and I hadn’t touched it in years.

    Within the span of 3 months, my water heater, plumbing, car and washing machine broke down. I had the water heater and the washing machine replaced, the plubming and the car fixed.

    It cost me slightly over $10k.

    Boy, was I glad to have that emergency fund, or I would be neck deep in trouble right now!

    • Steve Stewart says

      August 6, 2014 at 7:14 am

      Yay Tamara! That is exactly why we have emergency funds. Great job!

  4. Allan says

    August 28, 2014 at 5:36 am

    I don’t fully understand the technique regarding using the emergency fund to help pay off the mortgage. Our monthly P & I payment is $1200 with 8 years remaining. How would we use your technique with our numbers? Since we still have to budget for our monthly payment, I don’t understand how we would use our emergency fund?

    • Steve Stewart says

      August 28, 2014 at 3:30 pm

      Hi Allan!
      Let me give you an example, similar to what Meg (Sparing Change) said in the comments above:

      Your basic expenses with $1,200 mortgage is $4,000 a month. If you chose to have 6 months of expenses then you would want a total of $24,000 in a savings or money market account.

      However, if you paid off the mortgage then your basic expenses would become $2,800 and a 6 month emergency fund would only need to be $16,800.

      If you had been living consumer-debt free with a 6 month emergency fund of $24,000 then towards the end of your term you could pull $7,200 out to pay it off early ($24,000 – $16,800 = $7,200). This leaves you with $16,800 emergency fund and NO HOUSE PAYMENT! That is not a bad place to be!

      Of course, these numbers did not include taxes and insurance which do need to be included in your emergency fund calculation.

      It also did not include the $2,500 you may want to use for a trip to Disneyland to celebrate!

      Did this help?

  5. Allan says

    August 28, 2014 at 3:52 pm

    Yes, Steve, thank you for the quick response, even though it is an old podcast! It makes sense in the context of paying off the mortgage earlier, but only towards the end. Since we have 7 years left, this doesn’t appt yet, but it will be less than 7 years for sure! Thanks again.

    • Steve Stewart says

      August 28, 2014 at 6:16 pm

      I’m sorry Allan. I will try to be more specific next time so there is no more confusion.

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