Education News

23 February 2009

Reader Question Regarding Emergency Funds

Posted by forex under: Business; Debt; Forex; Investment; Money .

I received the following email this morning from an AFM reader:

Hello,

I read your blog (and a few other financial blogs) mostly every day. I read a lot about the importance of keeping a liquid emergency fund for about 6-months worth of expenses. What I have not heard however, is what basis that 6-months is calculated on.

1) Do you include any employment insurance benefits as a reduction in the amount required?
2) Do you use your regular expenses as a guide for spending? Or can you take credit for some reduction in discretionary spending?

Just looking for some opinions / guidance as I’m fairly new out of university and think it is important to have some level of financial stability. Thanks!

Brandon

First off, the “rule of thumb” is three to six months of living expenses. Where and how they came up with that number I’m not sure.

1) Do you include any employment insurance benefits as a reduction in the amount required?

As far as I can tell, the “rule of thumb” does not take into account unemployment benefits. So, unemployment benefits would reduce the amount necessary in your emergency fund. However, keep in mind that in addition to providing your day-to-day income needs, your emergency fund will also need to provide a cushion for unexpected needs that will pop up (car repairs, plumbing problems,…). So, I would look at unemployment benefits as just that: a benefit.

2) Do you use your regular expenses as a guide for spending? Or can you take credit for some reduction in discretionary spending?

During a period of unemployment, you would be advised to cut out all unnecessary expenses. Afterall, you don’t know how long you’re going to be unemployed. Plan your emergency fund need on a reasonable budget to give yourself some leeway during a period of unemployment. Some needs will be reduced while others may pop up. For example, you may need to buy a new suit (if you don’t already own one) in order to go on job interviews.

I think the main thing to keep in mind when it comes to emergency funds is to HAVE ONE! Too many people have nothing set aside and have nothing to fall back on in times of need.

One last thing: I would avoid using credit cards if at all possible. Charging up your credit cards and then not being able to pay them back would be devastating to your financial situation as well as your credit score.