If you read personal finance books or blogs, you’ve almost certainly heard experts advising you to maintain an “emergency fund.”
An emergency fund is a sum of money you set aside in case of an unexpected event, such as a medical crisis or a job loss.
Experts are divided about how much to set aside. Here are a few ideas, along with the pros and cons of each suggestion.
Save 3 to 6 months of expenses
Having at least three to six months of expenses set aside can help you in times of crisis. If you lose a job, you will have up to six months to search for a new position before running out of money.
However, some people argue that this amount isn’t enough. If you lose your job and simultaneously face another financial crisis — such as a broken-down car, storm damage to your home, or a major health issue — you won’t have enough to cover it all.
In addition, it may take longer than six months to find a job.
Save 7 to 9 months of expenses
Having seven to nine months of expenses saved can help you endure the type of situation described above, in which several financial hardships strike you at the same time.
But some experts argue that this is too large of a sum to keep in cash. They say this money could be better used to pay down debt, contribute to retirement accounts or otherwise invest in the market.
Today, the interest from savings accounts does not even keep pace with inflation. As a result, keeping a large amount of money in savings will cause you to lose purchasing power over time.
Save 10 to 12 months of expenses
Saving 10 to 12 months of cash almost certainly will tide you over through a prolonged job loss or major financial hardship. Additionally, dual-income couples who both lose their jobs will be relieved to have 10 to 12 months of expenses socked away.
On the other hand, keeping this money in savings comes at the “opportunity cost” of not making extra payments toward your mortgage or other debts, as well as not maxing out investment opportunities.
If you are the sole breadwinner for a large family, work in a tight industry and have no other sources of income, it might make sense to keep a large emergency fund.
On the other hand, if you and your spouse are in a dual-income, no-dependents situation, you both have stable jobs in high-demand fields, and you earn consulting or freelance income on the side, three to six months of savings may be enough.
Ultimately, you should choose the option that allows you to sleep easily at night.
Paula Pant helps people ditch the cubicle and live on their own terms. She’s traveled to 32 countries, owns seven rental property units and hasn’t had an employer since 2008. Her blog, “Afford Anything,” is the gathering point for a tribe that refuses to say “I can’t afford it.” Follow Paula on Twitter: @AffordAnything.