25 Rules to Grow Rich By #13: Emergency Funds

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #13: Keep three months’ worth of living expenses in a bank savings account or a money-market fund for emergencies. If you have kids or rely on one income, make it six months’.

This is an appropriate rule #13, as it covers a scary situation that most of us don’t want to think about: emergencies. What will happen if you lose your job? What will happen if the transmission dies in your car? What will happen if you get spinal meningitis? These seem like unlikely things, but eventually something disastrous will happen and you need to be prepared.

This rule is a solid one, but it doesn’t cover every situation. For example, larger households should have more than six months of living expenses in the bank, while single people can get by with as little as two months. Why is this? A household includes people that are entrusted with the responsibility of keeping a child (or children) safe and secure, and the more people in the household there are, the greater the likelihood that an unexpected event could happen.

In short, if you have a large family, you want to be sure that even if two or three bad things happen at once with different family members, you’re fine. That’s why it makes sense to have a certain amount in an emergency fund for each family member, so that your emergencies won’t affed them and vice-versa.

How much is appropriate for each person? Three months is nice, but it is not quite necessary to have a year’s worth of living expenses sitting around for a couple with two kids, plus three is a little bit high for a single person, anyway (unless they like the security blanket). Two months of living expenses per household member is a much better balance of security and reality. So, let’s rewrite that rule.

Rewritten Rule #13: Keep two months’ worth of living expenses in a bank savings account or a money market account for each person in your household. So, if four people live in your household, have eight months’ worth of living expenses.

You can jump ahead to rule #14 or jump back to rule #12.

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6 thoughts on “25 Rules to Grow Rich By #13: Emergency Funds

  1. Jeremy says:

    The emergency fund rule is a good one, although unfortunately it is one of the hardest ones to actually implement, at least for us. We are making a big push at putting as much money as we can towards debt and retirement, and the emergency fund savings builds at a much slower rate, and generally never gets much more than 1 month worth of expenses.

    And a painful lesson this week, we had some emergency vehicle repairs to be done and the bill came and it was far more than expected, wiping out almost our whole emergency savings. Now we are back to square one to build it back up again.

    We could have used a credit card, but we haven’t used credit in nearly 8 months, and I didn’t want to start now. But it just goes to show you that emergencies do happen and having enough cash on hand to cover it can be very important. After this incident I think we will make a stronger push towards building the fund up a bit more quickly.

  2. Matt says:

    I like your augmentation to the rule, 2 months per person in the household is a good idea. The big problem with having a large emergency fund is actually leaving it alone; big screen TVs occasionally go on sale (even if you don’t need one)

  3. Ken Silver says:

    If you don’t use the reserve or emergency fund, then it is dead money, essentially wasted because it is not being recycled (I believe money is meant to be churned and moved around – not act as an emotional pacifier). The answer is not to have hard cash as an emergency fund, but to use credit. A credit card filled with the appropriate balance, tucked away in an envelope in your safe, does exactly the same as an emergency fund. Then the money you saved can be used to advance your career, add to the house, or have fun. Of course, if you are the kind of household that regularly uses such a fund, then savings will be more economic.

  4. Melody says:

    Ken, that’s great if you have the financial ability to pay that credit card off when the bill comes in! If not, it’s not only going to cost you the emergency amount, but the interest on that emergency amount, as well.
    Also, another caution against that. I have had several credit card companies lower my balance limit specifically because it wasn’t being used! So you need to watch those things. The best thing to do is what is advocated here – sock away the cash and earn interest on it if you can. That way, if you have to spend it, hopefully you can minimize the damage that would occur today (if you’re me) by having to take out a loan or use another type of credit.

  5. Dollar Dee says:

    I’m single and I put away about 40 percent of my take home pay in a money market account every month. I also have a 403B with a company match that will be my retirement nest egg. I think living below my means and putting that extra money in a basic savings account makes the most sense because I can feel secure knowing if I need another car (the one I have now (a Volvo s60) is used and cost me $12,699, which I paid in cash) I can pick the one I want and pay for it outright. I can also replace my furnace, water heater, central air, and other expensive household appliances if they break down without worry. I also like seeing my savings grow and the satisfaction that comes from having the discipline to live below my means and regularly deposit large sums of money into my account. With my personal savings and retirement dollars I should be fine.

  6. Kris says:

    @ Ken Silver – In my opinion, that has to be the worst advice I have seen. An emergency is the absolute worst time in your life to rack up more debt ( especially if that emergency is a job loss ). I personally don’t feel that having money aside for emergencies is “Dead” money, the only thing I can think of that is truly dead money is paying interest to credit cards, cars, student loans etc..

    @Robert – don’t invest emergency money in anything other than savings or money market account. You don’t want your money to be at risk. As we have learned with the recession, when emergencies hit on a global scale, the market is usually down so odds are that your “fund” will have lost money that you now need.

    While I think Trent’s re-written rule could be a little over conservative for families that have 4 or 5 kids or more, but in general, its a good rule to go by.

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