How Much Money Should You Have in an Emergency Fund?

[00:00:00] Eric Brotman: This is Eric Brotman, the host of Don’t Retire… Graduate!:The podcast that teaches you how to advance into retirement rather than retreating. Welcome to office hours where we answer listeners questions about personal finance, retirement readiness, and more. We received a question from Jenna who asked how much should I have in an emergency fund?

And Jenna, that’s gonna depend a lot on not only your income and your routine expenses, but also the type of emergency we’re talking about. So there are certain times in life where it makes sense to have a significant cushion of actual cash available. And some of them are for just periods of unemployment or they’re for medical emergency or they’re for something around the house.

You have a, suddenly you have a leak in your roof and you need to take care of something. So there are some emergencies like that that require you to have some cash or available credit. So for certain types of things, you can have an emergency fund that has several layers. Think of it like multiple moats around your financial castle.

The first ring of that moat is your savings account or your cash cushion. And, you know, there are rules of thumb around how much your emergency fund should be. And I, I generally don’t like rules of thumb because everyone’s life is so different, but I will give you my own sort of barometer for this. And that is if you’re in a single income household ,whether you’re married with kids and there’s one person working or whether you live alone. If you’re in a single income household, I normally like to see you have six months of expenses sitting aside in cash at all times. So that doesn’t mean six months of your gross income, because of course your gross income, you pay taxes on. It’s only the six months worth of expenses.

So if your expenses are $5,000, a month, it would be wise, I think in that situation to have $30,000 in cash available to you. If you’re in a dual income household, as long as the incomes are similar, you can typically get by with more like three months of expenses. And the reason that I say that is the only way you would need more than three months is if both parties were unemployed simultaneously and while that’s not impossible, you know, I, I guess if you work for the same company and the company closes or something that’s possible, but assuming you work in different industries, that’s not really likely. So in that case, having three months of your, of your expenses available means that if you have one income suddenly instead of two, you can stretch that three months worth into half the bills for six months.

So I hope I didn’t confuse you, but at the end of the day in a single income household, six months. In a dual income household, assuming the incomes are reasonably similar, three months worth. Now the next ring of this moat is just as important as the first one.

The first one is having cash. The second one is having available credit, which is where you can very quickly get to money, ideally inexpensively, potentially tax deductively, but without a lot of hassles and without a, a tax impact. So that means if you own a home and you have equity in your home, it means having a home equity line of credit for emergencies, it’s not something you want to use all the time.

You don’t wanna carry a balance on it long term, but if you suddenly need capital for a period of time, it’s a good way to use that and to leverage and unlock that collateral. So if you own home, it’s a home equity line of credit. If you have a securities account that is not an IRA, so not a retirement plan, but just a, a mutual fund account or a securities account, a brokerage account.

You can create what’s called a securities backed line of credit, which allows you to collateralize your investment accounts so that if you suddenly need five or 10 or $15,000 and you need it relatively quickly, you don’t necessarily have to sell securities in order to get your hands on the money to use.

And ideally, this is for short term types of things, but you don’t wanna create expenses and taxes and other things just to get your hands on some resources. And then the third type of line that I like a lot is if you own whole life insurance. You can do a cash value line of credit or an insurance backed line of credit.

They go by both names, but it would allow you to essentially have your own cash value available to you as a line of credit so that you don’t have to go through the process of borrowing directly from an insurance policy with an insurance company. And the reason I say that is that the line of credit can usually be tapped in three minutes, whereas a loan from the insurance company could take days. So if you have a true emergency and you need to get your hands on it, it’s better to be able to get it quickly. It’s also better to be able to get it in something that’s free. Your home equity line of credit, your security’s back line of credit and your cash value line of credit should not cost anything to establish.

There should be basically no annual fee on it. If there is, it should be nominal and you should only pay it if you, if you use it. So the first question about the emergency fund is start with those three to six months of expenses, then make sure that you have as much credit available to you as possible.

The third rung of that. Assets that you can readily turn to cash if you need to. And that would be things like your, like your brokerage accounts or savings bonds or, or things that you could sell without having a penalty. You know, if you’re 40 years old, don’t, don’t include your 401k there because I know you can do a 401k loan, but those are brutal for lots of reasons.

And if it’s not a 401k, but it’s an IRA, you can’t borrow from it. So you’d have to make a withdrawal. And that would subject you not only to taxes, but to penalty. So that is not a good emergency fund. So you start with cash, then you go to available credit and then you go to liquid assets that you can convert to cash if you need to.

And that three-pronged approach will let most households survive almost any type of emergency. And so I hope that was helpful, Jenna, that that is a great way to get started. And of course, if you’re building that emergency fund, but you have other debt, personal debt and other things, you may not be able to tackle the emergency fund as the top priority, but it should be high on the list.

And being debt free is obviously one of the things that comes first, but beyond that, having some cash available makes a ton of sense. So I hope that was helpful. And I thank you for your question. If you’d like to send us a question, which we might answer in a future episode of office hours, post it on our Facebook page, or tweet us at @brotmanplanning..

If you like what you hear, please subscribe to our podcast and leave a rating on Spotify or wherever you listen to your favorite shows. Please also check out our books, workbooks and online financial literacy resources at brotmanmedia.com. Thanks for coming to office hours. Be sure to tune in for new content every Thursday.

For now, this is your host, Eric Brotman, reminding you: don’t retire. Graduate!

[00:06:25] Narrator: Securities offered through Kestra investment services, LLC. Kestra IS member FINRA S I P C investment advisory services offered through Kestra advisory services, LLC. Kestra AS an affiliate of Kestra IS. Kestra IS or Kestra AS are not affiliated with Brotman financial or any other entity discussed.