Everyone in personal finance agrees that you should have an emergency fund. If you have one, you are already ahead of most people as 64% of Americans don’t have $1000 in savings.

So the question becomes, “How much of an emergency fund is appropriate?” It’s a question that has been debated for ages… and even after this post it will still be debated.

The problem is that because there’s no clear-cut perfect solution for everyone. People have different risk tolerances. People have different job securities. People have different expenses. People have different assets.

News Flash: People are different.

Many magazines only have a couple of sentences of space to devote to emergency funds. The result is the quick quote of having 3-6 months of expenses. It is actually surprising useful for just a few words. Let’s assume you want to go deeper.

Determine a Unit of Measurement

It might seem natural to just assume that we go with dollars. People save dollars… not goats (usually). However, let’s not jump there yet. (Give goats a chance.)

The rule of thumb does a very smart thing. It forces people to calculate their expenses, which eliminates one variable. Buffy might have expenses of $2000, while Faith might have $5000 a month in expenses. Buffy’s rule of thumb range could be $6,000-$12,000, while Faith’s would be $15,000-$30,000. It is quite a difference, right?

So we aren’t going to with goats as our unit of measurement. We’re going to stick to months of expenses… and we’re going to assume that you can roughly do those calculations.

Try your best to prepare for a doomsday scenario. If you have a rental property with a good tenant now, imagine that the tenant leaves and you have that expense without a corresponding income. Such a scenario could significantly raise your expenses, so I might only consider 50% of the rent, hedging for the likelihood of not having to get a new tenant at the time of the emergency.

Whatever number you come up with, I’d pad it by 20% to cover forgetting something and/or other surprises.

What Is Your Job Security

For a lot of people this is very difficult to answer. There’s isn’t going to be an answer like 3.141593. It isn’t easy as pi. I’d recommend breaking it down into 5 areas such as: poor, fair, average, good, excellent. If you were a temp worker, you’d say poor. If you worked in a small start-up, you might go with fair. If you were a teacher with tenure, you might go with excellent.

You might have a spouse, which complicates things (usually in a good way). If both of you work, you have some extra security (but you probably have higher expenses.)

What Are Your Assets?

This is rarely discussed when it comes to emergency funds, but I think it is very important. If you have a Roth IRA or equity in your home, you might have a hidden emergency fund. Most people may not know they can pull their original contributions out of a Roth IRA with no penalty. These aren’t necessarily the best places to get money from, but it is an emergency fund, not a “buy the best television ever” fund.

Imagine you have $5 million worth of mutual funds. While this far from a typical imagine how that might impact your emergency fund planning. You could have $1 million dollars in a relatively stable investment that could provide you with years of emergency protection. Some people have this… on a small scale obviously.

I recently wrote about having money in Lending Club (Review), which could pay decent income in times of emergency. In the meantime, it is making me 7% interest.

What Is Your Risk Tolerance?

I’m aggressive and I know it. I invest aggressively, because I’m young. Being aggressive has usually paid off for me. I should say that I perceive that it has, which may or may not be due to selective memory.

Maybe you are safe and conservative. It’s cool, we welcome all kinds here.

Maybe you are somewhere in the middle. We can work with that too.

I wouldn’t go too much further than to put yourself in one of those three categories.

Answers, Damn it!

Up to now I’ve given you more questions than answers. Time to fix that problem.

What I’ve really been trying to do is feed you with the information that you can use to find what is the right emergency fund for you. In a strange way, I tricked you into doing one of those quizzes in magazines. Did you catch me?

We start out with baseline of 2 months of expenses in your emergency fund. Now look at your job security rating. Rate it from 1-5 with excellent being a 1 and poor being 5. Add that many months to the baseline. So if you have poor job security you are looking at 7 months. If you have excellent you are looking at 3 months.

Next look at your risk tolerance. If you are aggressive add a month. If you are conservative add 3 months. If you are in the middle… well if you can’t figure this out, you are doomed anyway. Now the possible range could be from 4 months to 10 months depending on those two factors.

Now we want to convert these months to dollars. The good news is that we already discussed this (and goats) above. The calculation is really easy, it is the calculation of expenses that is difficult.

Finally, take a look at your assets.

Your assets may already be worth tens of thousands of dollars in an emergency fund. It is my opinion (and I want to stress that), that if you can have half of your emergency fund in these assets. The other half you probably want to have in a cash or near cash equivalent.

The key to counting your assets as part of emergency fund depends on them being relatively stable. That means you don’t count that Groupon stock you own. You have to be careful what you consider stable. Sometimes you may think they are stable, like home equity only to see a housing crash makes it all disappear.

Example: My Emergency Fund

My wife is a military officer and has excellent job security. I’m a blogger with what I’d say “poor” income reliability. The combination of the two incomes with the level of security puts us in the excellent overall job security section. Think of my “poor” income reliability as an extra bonus to my wife’s excellent job security. That’s worth 1 month.

As I mentioned above, I’m very aggressive in my risk tolerance. That’s worth 1 month.

Add those two months to the baseline of 2 months and we need to have 4 months of an emergency fund. We have around $4500 in expenses for our rental properties so 50% of that is $2200 (remember we are presuming that tenants may not pay rent or move out). Add that to our own $2800/mo. mortgage, we’ll need ~$5000/mo for housing. Add $2000 for car payments and child care and we are up to $7000 with just the big stuff. Add another $1000 for food, utilities, insurance, and other expenses and we are up to $8000/mo. Add another 20% for padding and we are up to $9600/mo.

That’s a lot of money. A majority of that comes from housing in which all the mortgages were 15-year fixed. If we went with 30-year fixed like most people, the emergency fund would be cheaper.

Multiple that by 4 months and we should have an emergency fund of around $38,400. That sounds like a lot of money to keep around in cash. This is where having 50% of that in stable assets can really help. With more than a dozen years of maxing out Roth IRAs and equity in the homes, we have access to a lot more than $38,000 if we need it. Ideally we’ll only count that as half of our emergency plan and count on keeping at least $20,000 around in cash.

Conclusion

At the end of the day, an emergency fund is a very personalized thing. It would be nice if I could have just said, “You need $10,000”, but I can’t. Hopefully this gives you a blueprint for how to know what is the right emergency fund for you.

I do, and I didn’t even know it.

A couple of weeks ago, I mentioned that we activated ultra-frugality mode due to the expensive mold removal in one of our investment properties. What was once a very cushy bank account is now looking lean… leaner than it has been in years.

It got my wife worried.

To be honest, it got me worried too, I didn’t want to have an overdraft situation on my hands. There’s always a small gap from when mortgage is due on the first and when the tenants’ checks get through the mail. I mentioned to the wife that we should tap the emergency just to make sure we don’t overdraft at the end of the month during this time.

This worried my wife even more. There’s clearly something “not good” about tapping an emergency fund. However, this is exactly why it exists. In a few days, we can probably move the money back.

This exercise got me thinking, how can I assure my wife that it is “okay” to use this emergency fund. The answer, of course is our hidden emergency fund. You don’t have one? Maybe you do and it is so hidden that you don’t know about it.

I’m going to share with you my secret, hidden emergency fund. It consists of:

• Our Home Equity – We have about $100,000 in home equity in our primary residence. I am fairly confident that our bank would extend us a Home Equity Line of Credit (HELOC), but this is something that I should have set up before now. Perhaps better late than never. Yes, using a HELOC is not an ideal situation, but we are talking legit emergencies here.
• My Roth IRA Contributions – As Jonathan from My Money Blog points out, you can withdraw your Roth IRA contributions penalty free. He makes the point that it should be funded before an emergency fund, because it essentially doubles as an emergency fund that is typically growing in the stock market. Again, this isn’t an ideal situation because you’d want that money in the account growing, but for true emergencies it isn’t a big deal. Maxing out your Roth IRA for 10-15 certainly has its benefits, doesn’t it?
• Our Excess Possessions – Remember when I bought a $60 ball? I don’t use it that much. I could sell it on Ebay and probably not miss it. That’s just one item that is lying around my house. Now if only my gargantuan collection of personal finance books had any value.
• Ultra-Frugality Mode Itself – Some may not consider this an emergency fund, but we have a ton of food around the house that we need to eat down. We could probably not buying any new food for couple of months (other than milk, eggs, and produce) and instead use up what we have. In fact, we are doing just that with fairly good success. Money that we aren’t spending is money that is going to go straight into our bank accounts.

I hope when my wife reads this, she’ll realize that we have emergency funds on top of emergency funds. It’s fun to realize that you had more emergency fund than you thought.