How much of an emergency “cushion” do you have to fall back on?
Picture this. You show up at work one day only to find out your job got eliminated in a company retooling.
It’s possible. While the most recent economic data shows that the job market appears stable, companies continue to report large-scale layoffs, casting a cloud of uncertainty for the long-term economic forecast.
In the latest report from the U.S. Department of Labor from July, 12.8 million Americans remain unemployed, including more than 40% who have been out of work for six months or more. Older Americans are especially hard hit. So relying on the classic rule of thumb – three months’ expenses – may no longer carry you during a prolonged job and housing market recovery.
Experts, including personal finance expert and Dimespring columnist Jane Bryant Quinn, now suggest a savings cushion of anywhere from three months of living expenses to a full year, if you’re older and your job is vulnerable.
While that’s a wide margin, you need to start somewhere.
“It’s never a problem until it’s a problem,” says financial planner Ann Reilley Gugle of Alpha Financial Advisors in Charlotte, N.C. “Some folks have emergencies and have to tap into their retirement fund.”
Gugle suggests you build a fallback cushion of three months, if both spouses work, but six if only one works full time. If you’re single, aim for six months of expenses. That is, unless you've got another income source, such as alimony or, for the lucky few, a trust fund. It all depends on your circumstances.
To get started, dig into your expenses to figure out how much you spend in an average month. Begin the process by scrutinizing up to a year’s worth of spending to determine the monthly average, Gugle says.
She suggests leaving out the big-ticket expenses, such as a vacation or the cost of replacing a heating and air conditioning unit. Those items go into your budget under “the unexpected.”
Calculate what you’ll need for your fund. Then determine where to park the money. Before the recession, consumers put their savings in short-term CDs (or certificates of deposit) or money market funds. These days, savings accounts offer just about as much quick access and comparable savings rates.
Next, it’s a good idea to scrutinize your budget to see where you can shave expenses, because that can help you build your emergency fund more quickly.
Quicken Loans highlights the $5 savings plan on its Zing blog, which requires to save every $5 bill that shows up in your wallet. Instead of spending it – you stash it away, in a special envelope or jar. Silly? If you save $5 per day, your fund would grow to $1,825 by the end of a year. You can also save $1, or $10. You decide.
Depending on the fund size that you need, it can take from six months to a year to grow. Just remember that your effort will be rewarded if you’re faced with that unexpected emergency.
“It’s never too late to get started,” Gugle says. “The sooner, the better.”
Do you have a secret to building your savings? Tell us about it below.
Morningstar.com's Rachel Haig offers advice on setting up an emergency fund.