During Microsoft’s early days, Steve Ballmer presented his growth strategy to Bill Gates. More specifically, Ballmer wanted the company to hire 17 people in order to reach their objectives. Gates, who strongly opposed the idea, said that the expenses associated with hiring new people “would expose [Microsoft] to financial ruin”. Instead, Gates wanted his company to “have enough cash on hand to go a year […] without a penny of revenues”. This leads us to the question of how much emergency fund savings you need to have.
Unfortunately, the majority Americans are not financially prepared to deal with an emergency. In fact, almost two-thirds (or 58%) of US consumers have less than a $1,000 in their savings account. This means that, in case of an unexpected event, most people are largely exposed to increased debts and other problems.
Having a rainy day fund is important for several reasons. When your savings can cover several months of expenses, you can handle emergency situations effectively and unexpected events become even more likely to pass by quickly. Moreover, a sizable savings account will also help you in case you lose your job or another source of income while dealing with unforeseen problems.
How Much Emergency Fund Savings Should I Have?
The answer largely depends on your specific situation. However, most experts recommend that you have three to six months’ worth of expenses saved up. There are several reasons why this approach is effective.
Emergency situations, in themselves, are very difficult and stressful. At times, your spouse or child might be in the hospital for a prolonged time. Some people might even have to travel abroad to help relatives and family members who are in need. While calculating your medical bills or travel expenses, the last thing that you want to deal with is a past-due payment that you need to make.
With a large enough savings account, you can give your emergency situation the attention that it deserves and immediately resolve it. Doing so becomes much easier when all of your bills are paid off.
Just as importantly, you want to be prepared in case you lose your job. If you have to spend time caring for a sick family member (and, therefore, not go to work), you are more likely to be fired or laid off. This, in itself, is its own emergency. Therefore, how much emergency fund savings you need will have to cover any potentially lost wages.
Your Peace of Mind and Savings
Image if you lose your job, can’t pay your bills, and, on top of that, have to spend time and money on medical care. Not only is this bad for your mental health, but it also creates a snowball effect that, in turn, will make each of your problems bigger.
First, you have to pay unexpected and hefty medical and/or travel expenses. This makes it difficult to take care of your normal monthly bills. In this case, you can either borrow money (and increase your monthly expenses by adding the loan installments) or watch your credit score plummet (because of late payments).
Regardless of what happens, each of those problems will continue to grow and create more issues down the road. Losing your job, on top of all of this, makes the snowball bigger and more difficult to deal with.
Going back to our original question: How much emergency fund savings should you have? At a bare minimum, it needs to be enough to cover your essential expenses for three months. This would account for the potential loss of income if your employer lets you go.
Keep in mind that finding another job can take a few months. The emergency fund will keep your bills paid during that time. Otherwise, the pressure might force you into accepting any type of work and settling for less pay.
In an ideal situation, you want to have the equivalent of six months of bills in your savings account. If possible, that should cover both essential and luxury items. After all, life will be easier during emergencies when your kids don’t have to sacrifice their TV shows, as an example.
What About Insurance?
Needless to say, having renters or homeowners insurance is a key way to be prepared for emergencies. Your health policy is also crucial. You can easily get a cheap renters insurance policy for less than $15 per month, which would give you protection against fires, floods, and similar events.
However, relying on insurance, whether it’s health or renters’s/homeowner’s, is far from ideal. There are many instances that your renters policy doesn’t cover. Similarly, your health plan might have copays or deductibles that you must settle out-of-pocket.
Just as importantly, in case you lose your job, the health insurance benefits will automatically go away. Therefore, your emergency funds should take into consideration the potential of purchasing a new health policy.
Another unreliable alternative to an emergency account is your 401K or children’s college savings. After all, these funds are there for a reason.
You can withdraw money out of your 401K or Social Security account, but that means that you will either have to delay your retirement or make future financial sacrifices to make up for the losses. The same logic applies to your children’s college savings.
Many people consider Bill Gates to be overly paranoid. However, by consistently planning for the worst case scenario, Gates was able to lead Microsoft through the dot-com bubble and the Great Recession.
Unexpected emergencies have both direct and indirect financial implications. Apart from dealing with the situation and its associated expenses, you will need to continue to pay your bills on time. Otherwise, it could take you months, if not years, to recover from a job loss or damaged credit score.
How much emergency fund savings you need to have should be enough to cover housing and living expenses, as well as your debt payments. Doing so will make it easier to deal with unexpected situations and quickly return to your normal life.
While insurance policies can help, you expose yourself to a lot of risk by solely relying on them. Similarly, you might have to retire at an older age and make up for any withdrawn amount out of your 401K, Social Security, or children’s college education accounts.
“17 people? You want to bankrupt the company? 17 people? No Way!”. Gates’s reaction to what Ballmer suggested can teach us a lot of lessons. “17 people? Microsoft would never expose itself to financial ruin!”.