The first real taste of financial independence is when your savings are sufficient to give you peace of mind. Savings are the essential first step upon which all your future financial success will rest. Do you have enough saved?
How to Find the Right Amount of Emergency Savings
Whether you are just getting started or are already on your way, it is important to reassess your savings periodically. Your savings number is a dynamic amount that changes with your lifestyle and as expenses change over time.
The standard guideline is 3-6 months expenses. Though a good start, knowing an actual number is a lot more useful.
Here’s how to calculate your emergency savings number
- Determine Monthly Expenses
You’ll need bank and/or credit card statements from the last 3 months. Details below.
- Determine how many months you need to save.
This is driven by your lifestyle. Details in section.
Multiplying these two will give you your savings number.
1. Determine Monthly Expenses
It helps to break down monthly expenses categorically. This allows you to quickly identify where your money is actually going.
We’ll walk through some common expenses in each category (not an all inclusive list). You are going to need to check your bank/credit statements for the 2-3 months prior.
- Lawn/Other services
- Car Payments
- Estimate maintenance cost: Example- 1 oil change every 3 month is probably a reasonable assumption
- Any essential cost you can’t scale back on
- Eating Out
- Monthly Subscriptions
Seperate your expenses into these categories and then average your months together. This is your monthly expenses. Factor in any unique expenses such as a quarterly bill (or accounting for an oil change).
If you’re like me this number may be larger than you expected. Here’s some tips for managing expenses:
How to Reduce Your Expenses
Because you broke them into categories, you will quickly be able to see trends in your spending. Generally, the discretionary is where you can cut back the quickest. This is not to suggest you need to stop hanging out with friends or doing things that make you happy.
We all have subscriptions we don’t use but are still paying. You may also realize that a lot of expenses aren’t really important to your lifestyle. Cutting back on these small expenses will start to add up big.
How To Keep Your Expenses Low
If you are young and have relatively small monthly expenses those will likely increase over time. Be deliberate about expenses in the housing and transportation category. These are large monthly expenses and are very difficult to get rid of in a timely manner. Some specific tips include:
-Try subtracting the cost of a car payment for a car you want before buying it. This is the best way to determine if you are comfortable with this higher expense before you are committed to it. Our article: How To Determine How Much Car You Can Afford will help you in this process.
-If you are buying a house for the first time, keep it simple. Buying a house that’s enough for your needs will keep you from wasting a ton of money. Remember, there are a lot more expenses than just the mortgage.
2. How Many Months Do You Need for your Emergency Savings?
Determining the amount of months you need saved is a result of:
- How simple or complicated your life is. Having houses, kids,etc. increases the chance that an unexpected expense will occur.
- Your comfort level: No amount of math can replace the feeling of no longer having to stress about making ends meet. If having more saved helps you get there: so be it.
Here are some guidelines. They’re not all inclusive.
So there you have it: Multiplying a month of expenses times the amount you need gives your savings number. This brings us to our calulator.
The Emergency Savings Calculator
You can use our calculator to create your plan of attack to reach your savings number. Set the interest to whatever your bank account is yielding and use it to see how long it will take you to save.
We recommend focusing on reaching your emergency savings number before moving on to other goals. Sufficient savings is the crucial first step from which you can achieve your goals.
Why Does our Emergency Savings Calculator have interest?
Our savings calculator has interest because it can also be used for targeted savings.
Targeted savings is savings that you have on top of your emergency savings for a specific expense (like a home downpayment) that will occur within the next 5 years.
Unlike your emergency savings which will have a close to zero interest rate you can actually invest targeted savings in securities like I bonds and get a safe return on your money. The interest rate helps you determine what you will need to save accounting for the return you expect to earn helping you get there.