Yesterday, I mentioned my desire to have a twelve month emergency fund, which resulted in some very interesting discussion. Some of the readers thought it was a good idea – others felt that it was simply too much and that I should invest some of it.
Back in April, one of my favorite bloggers covered the idea of “too much” emergency fund in detail and concluded:
Ideally, your emergency fund should be able to cushion the worst possible scenario (specific to your personal situation) that you can imagine (“end of the world” is not a valid scenario). Add a 20% margin of error to that estimate (roughly) and aim for that emergency amount. The right amount will be something that makes you feel “safe” after considering the worst case scenario. More than that is probably “too much”.
This brings us back to the idea that personal finance is more personal than finance – something I believe in greatly. I think it makes a lot of sense to walk through a worst-case scenario in detail, but to remember that that worst case is something different for each person. So, here’s my worst case scenario and why the idea of a twelve month emergency fund appeals to me:
We have a third child and that child is born with a birth defect, which means we incur medical costs all through his/her life. Shortly after the child is born, I lose my job and on my way home I get really upset and proceed to run my truck into my house.
This is the worst-case scenario I envision that doesn’t involve a death. Is it realistic? Probably not. Does it keep me up at night? Not really. But there are a ton of pieces of this scenario that are possible, and they all result in having to spend significant amounts of extra money.
Outlining that worst-case scenario is one’s living situation. For us, we already (effectively) have a household of four with two children under the age of two who are basically incapable of caring for themselves, and we are thinking of following up with another one (at least). I have the financial means to plan for a worst-case scenario that enables their lives to continue in much the same way as before, with the safety of home, a fairly regular way of life, and parents that love them.
Another big piece of the puzzle is your values. I want to always show them by example that self-reliance and preparation is the best way to live so you can simply roll with any punches that life hands to you.
After running through the numbers on this scenario and others, I concluded that a year’s worth of salary is an appropriate emergency fund. For most people (not having multiple young children and not placing a large emphasis on self-reliance), a smaller emergency fund makes a lot of sense – in fact, I would say that our fund idea is far, far above the norm.
The lesson here? When you define your emergency fund, be sure to look not only at your worst case scenario, but the other pieces of your life that surround it, and consider your own personal values. There is no cut-and-dried formula for how much emergency fund you should have – it’s one of those things that really puts the personal in personal finance.