Financial Rules of Thumb: The Emergency Fund

April 11, 2025

People measure everything from their daily steps to how many hours they sleep and even how many calories they burn while they are sleeping. So, it’s no wonder that people wonder if what they are doing is considered “normal” in their finances. We like knowing where we stand and how we measure up compared to our peers.

But really, who’s to say what’s normal — is there even such a thing? This is why we have rules of thumb in the financial world. And while there are exceptions to all of the rules, they are generally good guidelines to help make decisions. For example, one of the more common rules of thumb is the importance of establishing an emergency fund (often called a nest egg or rainy-day fund).

How much should you have in your emergency fund?

Rule of thumb = three to six months of your expenses

While you may need more if you own a home that could be hard to sell, work in a highly volatile or specialized field or have a large family dependent on one income, this is a pretty good gauge of things to make sure you’re protected. Twelve months might even be more appropriate when real estate prices plunge, or jobs are a little hard to come by. There is no guarantee how long it will take to find new employment or sell homes if they are worth less than the mortgage.

What’s the emergency fund for?

Get you through an unexpected loss of income

The emergency fund’s primary purpose is to ensure you have the money you need to cover all your core financial expenses if you or your partner loses a job. Being unemployed is stressful enough, so it’s nice to know that you have money set aside so you don’t have to accumulate a mountain of credit card debt or miss payments that can impact your credit score. These savings will ensure this unfortunate event doesn’t cause too much long-term financial damage.

If the loss of income is more permanent, it’ll also give you time to adjust to a new reality, allowing you to keep paying your bills until you’re able to reduce them through cancellation or adjustment of service, sale of your home, or termination of your lease, etc.

Large unexpected one-time expenses

While you should be budgeting for most non-recurring expenses like home maintenance, pet illness, healthcare bills, etc., there are always things that come up that just can’t be planned for beyond having the proper insurance to minimize the impact. That said, it’s better to tap into these savings than it is to get into credit card debt that’ll amass hefty interest charges.

What it’s not there for

It’s NOT your piggy bank to tap into when you feel a spending itch or paying for expenses that you should plan for through your normal budgeting process like vacations, holidays, etc. Instead, this emergency fund is your safety net and can leave you in pretty bad financial shape if you don’t have it when you need it (and you will). That’s why the best emergency funds are those that are held in a separate account that’s a bit harder to access and remains untouched except in times of true emergencies. Once the emergency has passed, emergency funds must be brought back up to their necessary amounts to protect against the next thing!

So what do you do if you don’t have an emergency fund yet?

  1. Figure out your monthly fixed expenses: First, you need to know how much you should be aiming for. If you don’t know your monthly fixed expenses, that’s a great start. Our Expense Tracker tool is one way to figure that out, or you can use online tools, which will link directly to your accounts and download your spending. That exercise can also help you figure out how much you can afford to save each month.
  2. Open a separate savings account: Trust us. You’ll want to keep it separate to make it harder to tap into.
  3. Automate your savings: Set up a direct deposit or automatic monthly transfer to your separate savings account. Your payroll department may be able to even take money directly out of your check and deposit it for you. Otherwise, set the transfer for payday so you never even have the temptation to spend the money. Don’t beat yourself up if you’re still working on getting your emergency fund fully funded, as this takes some time.

Now don’t let the math freak you out. Six months of expenses is a big chunk of change! Start first by trying to get $1,000 in your account. Maybe start with $25 per paycheck. After that, aim for three months worth of your mortgage or rent payment. Then, tack on three months of car payments, utilities, etc. If you have any little windfalls like a tax refund or won on that scratch ticket your friends got you for your birthday, use that to get you there sooner.

Finally, it’s important to reassess the amount needed in your emergency fund when you have significant life changes such as the birth of a child, a new home purchase, or even an empty nest when the amount needed may actually decrease.

The bottom line is an emergency fund is your first line of financial defense against life’s little twists and turns. Even if you’re working to pay off credit card debt, it’s important to start your emergency fund to help you avoid derailing your debt pay-off plan should an unexpected expense arise. Don’t delay. Start saving today.

to all of these rules, they are generally good guidelines to help make decisions. Similarly, there are financial rules of thumb in the financial planning profession that we then customize to each person’s goals and values. For the next several weeks, I’ll be sharing six that we regularly use at Financial Finesse to answer these common questions:

  1. How much should I have in my emergency fund?
  2. How much do I need to save for college?
  3. How much do I need in order to retire?
  4. What percentage of my income should I save?
  5. How much life insurance do I need?
  6. How much house can I afford?

Let’s start with number one. How much should you have in your emergency fund? The general rule of thumb here is three to six months of your expenses.

However, you may need more if you own a home that could potentially be hard to sell, work in a field that is highly volatile or specialized or have a large family dependent on one income. When real estate prices plunged along with a lot of people’s job prospects during the last recession, twelve months would have been more appropriate. That’s how long it took many people to find new jobs when selling their home wasn’t an option because suddenly their houses were worth less than the mortgage.

The emergency fund’s primary purpose is to get you through an unexpected loss of income while causing as little long-term financial damage as possible. That’s why it’s also one of my personal financial ground rules. It’s also supposed to give you time to adjust to a new reality should you have a permanent change in income status, allowing you to keep paying your bills until you’re able to reduce them through cancellation or adjustment of service, sale of your home or termination of your lease, etc.

It’s NOT really intended to be what you tap for things like non-recurring but necessary expenses like home maintenance, new appliances, veterinarian bills, etc. Those should be worked into your everyday spending plan. The best emergency funds are those that are held in a separate account and remain untouched except in times of true emergencies. And once the emergency has passed, they are brought back up to their necessary amounts to protect against the next thing.

So what to do if you don’t have an emergency fund yet? First, you need to know how much you should be aiming for. If you don’t know what your monthly fixed expenses are, that’s a great place start. Our Expense Tracker tool is one way to figure that out, or you can use a free online tool such as Mint.com, which will link directly to your accounts and download your spending. That exercise can also help you figure out how much you can afford to save each month.

Then you just need to automate it by setting up a transfer to your separate savings account. Your payroll department may be able to even take money directly out of your check and deposit it directly. Otherwise, set the transfer for pay day so you never even have the temptation to spend the money. That’s what I do. (And yes, I’m still working to get my emergency fund fully set up, so don’t beat yourself up if this takes some time.)

Now don’t let the math freak you out. Six months of expenses is a big chunk of change! Start first by trying to get $1,000 in your account. I started mine with just $25 per paycheck!

After that, aim for three months worth of your mortgage or rent payment. Then tack on three months of car payments, then utilities, etc and if you have any little windfalls like a tax refund or you won the 50-50 drawing at your kid’s basketball game, use that to get you there sooner. Finally, it’s important to reassess the amount needed in your emergency fund when you have big life changes such as the birth of a child, new home purchase or even an empty nest when the amount needed may actually decrease.

The bottom line is, an emergency fund is your first line of financial defense against life’s little twists and turns. Even if you’re working to pay off credit card debt, it’s important to start your emergency fund to help you avoid derailing your debt pay-off plan should an unexpected expense arise. Don’t delay. Start saving today.

How to Avoid Borrowing From Your Retirement Plan

January 26, 2017

Have you ever borrowed from your employer’s retirement plan? When you need cash in a hurry, it can be tempting. After all, you don’t have to worry about a credit check and the interest just goes back into your own account.

However, there are a couple of reasons why this may not be the best idea. First, you lose any gains your money would have earned. Keep in mind that the stock market averages a 7-10% return per year, including many years with double digit returns so you could be losing out on real money.

Second, if you leave your job before paying off your loan, the outstanding balance could be considered a withdrawal and subject to taxes plus a possible 10% penalty if you’re under age 59 ½. These losses could end up jeopardizing your retirement. Here are some ways to avoid having to raid your retirement nest egg in the future:

Don’t think of your retirement account as a giant ATM. Even if your plan allows it for any reason, retirement plan loans should only be for dire emergencies and no, wanting the latest tech gadget or a vacation doesn’t qualify. Instead, calculate how much you need to save each month and have that amount automatically transferred to a separate savings account until you have enough to purchase what you want. Don’t have enough to save? Ask yourself what expenses you’re willing to cut back on to make your goal happen.

Have an emergency fund. Even if you do have an emergency, a retirement plan loan shouldn’t be your first resort. If your investments are down in value, you may not even have enough to borrow. Instead, build up enough savings to cover 3-6 months’ worth of necessary expenses and keep that money someplace safe like a savings account or money market fund. If you can’t stand the idea of all that cash just sitting there earning less than 1%, here are some ideas to put it to work harder for you.

Consider other options. For example, the average home equity interest rate is about 5%. Don’t forget that it’s tax-deductible too. If you’re in the 25% tax bracket, that loan may only cost you 3.75% after taxes, which is less than your investments will probably earn. Just be aware that your home is on the line if you can’t make the payments so this is probably not be a good idea if you’re facing severe financial hardship.

One final point is that people sometimes use a retirement plan loan to pay down credit card debt. Given how high credit card interest rates can be, this might be a smart move if it’s part of a larger plan to become free of high-interest debt. However, if you end up filing for bankruptcy, you’ll still have the retirement plan loan. In that case, you would have been better off using the bankruptcy to wipe out the credit card debt and leave your retirement account alone. (It’s generally a protected asset in bankruptcy.)

Retirement plan loans have a place, but be aware of the downsides. If you’re not sure what to do, consider consulting with a qualified financial planner. As with any financial decision, you want to make an informed one.

 

 

 

 

When Not to Pay Down Debt

June 09, 2016

In her new book, What Your Financial Advisor Isn’t Telling You, our CEO, Liz Davidson, writes about how paying off debt can be your greatest investment. As they say, a penny saved is a penny earned so if you pay down credit card debt at 19% interest, it’s like earning 19% guaranteed tax-free. But as with most financial planning guidelines, there are exceptions. Here are some situations where paying down debt may NOT be your best investment:

You can’t pay your bills. If you’re in severe financial difficulty, make sure you prioritize keeping a roof over your head, your car in the driveway, the lights and water running, and food on the table even over paying the minimum on your debts. Don’t jeopardize you and your family’s basic well-being to pay down debt that you might have to liquidate in bankruptcy anyway. In fact, if you think you might file for bankruptcy, don’t borrow or take withdrawals from a retirement account to make debt payments since those assets are generally protected in a bankruptcy.

You don’t have sufficient emergency savings. To avoid the problem above, you’ll want to have some emergency savings. You should have enough cash to cover at least 3-6 months’ worth of necessary expenses.

You can consider your ability to borrow from a retirement plan or the Bank of Mom and Dad as part of your emergency resources but not lines of credit since they can easily be cancelled, especially if you’re in between jobs or the economy is weak. This money should be someplace safe like a savings account or money market fund. Yes, the interest you’ll earn is probably much less than the interest you’re paying on debt, but how do you value avoiding eviction or foreclosure on your home?

You’re not contributing enough to max your employer’s matching funds. The only thing that beats saving 19% interest is earning 50% or 100% on your money. If you’re not maxing the match, you’re leaving free money on the table and getting behind on your retirement saving.

Your debt is costing you less than 4-6% in interest. If the interest on your debt is below 4-6% (after any tax deductions you get for the interest), you could probably earn more by investing extra savings (particularly in a tax-advantaged account) than you’d save by paying down that debt. That’s why they call low-interest mortgages, car loans, and student loans “good debt.” If the interest rate is between 4-6%, your decision depends on how aggressive an investor you are. Conservative investors would likely be better off (and happier) paying down the debt, while more aggressive investors are likelier to earn more by investing instead.

None of this is to suggest that paying down high-interest debt isn’t generally a good idea. These are just the exceptions. If you’re able to pay your basic bills, have sufficient emergency savings, are maxing the matching in your retirement plan, and have high-interest debt, paying it off IS your best investment.

The Other Pain After a Medical Emergency

February 16, 2016

My husband has been battling to keep his diabetes under control for the last few years. But no matter how diligent he may be, he still may find himself in the hospital. As we started talking about a recent hospital visit, he started sharing with me the financial lessons learned over the last few years. Continue reading “The Other Pain After a Medical Emergency”

The 8 Step DIY Financial Plan for Newlyweds

September 16, 2015

 

As newlyweds, my husband and I are just getting started on our money journey. To get and stay on the same page, we have a bi-weekly money meeting where we dig into our finances, which saves us from money fights and also keeps us accountable to completing tasks needed to get us to our goals. One thing we’re working on is creating our family financial plan to make sure we are fully aligned on money going forward, using these 8 steps. Even if you’re not a newlywed, you can follow these steps to get a plan in place for your family. Continue reading “The 8 Step DIY Financial Plan for Newlyweds”

What Alligators Taught Me About Budgeting

July 14, 2015

My family and I are history buffs so we try to choose cities with lots of history to visit. This year, we chose St. Augustine, Fl. It is considered to be the oldest city in the country and is full of historical sites and museums that kept the kids entertained. Continue reading “What Alligators Taught Me About Budgeting”

Is Paying Off Your Mortgage Worth Losing The Tax Deduction?

March 12, 2015
Updated June 14, 2017

I recently received a question after one of my workshops from a woman who was wondering if she made a mistake paying her mortgage off early because she no longer has the mortgage interest deduction. I can’t tell you how many times I’ve gotten different versions of that same question (including after a later workshop session that same day). Here are several reasons why this is a classic case of letting the tax tail wag the dog: Continue reading “Is Paying Off Your Mortgage Worth Losing The Tax Deduction?”

Money Management For a Busy Single Mom

March 10, 2015

Years ago, I had a friend who was trying to get her finances together but she was struggling as to how to do it. She was a single, recently divorced, full-time working mother of four, with three of the kids under the age of 5. I knew whatever strategy we developed had to be easy and automated. Continue reading “Money Management For a Busy Single Mom”

Lessons Learned From A Home Ownership Dream Gone Sour

February 17, 2015

Recently, I was talking to a friend and she told me that she was selling her home because her American Dream of Home Ownership has become an American Horror Story. She then sighed and said if only she can go back and advise her former self. I asked her what she would say and she began sharing her lessons learned. Continue reading “Lessons Learned From A Home Ownership Dream Gone Sour”

Should a Roth IRA Be Part of Your Emergency Safety Net?

June 02, 2014

Roth IRAs are increasingly becoming one of the most popular savings vehicles for retirement. The most appealing feature of the Roth IRA is that these type of retirement accounts offer tax-free withdrawals of earnings at age 59 ½ as long as the account has been open for at least 5 years. The term “tax-free” is quite appealing in the current economic environment where higher future income tax rates appear to be a real possibility. Millennials and Gen Xers, who may not be in their peak earning years, may be particularly prime candidates to contribute to a Roth IRA. Perhaps that is one reason why the growth in Roth IRAs far outpaces that in traditional IRAs as more account owners are choosing to use after-tax dollars to save for retirement to receive the tax break during retirement.  Continue reading “Should a Roth IRA Be Part of Your Emergency Safety Net?”

A Message in a Bottle

October 25, 2013

Sometimes I read something that touches me and makes me remember that, no matter what is going on in my life, things could always be worse.  And then I remember to pick myself up, dust myself off and get back to the business of living my life with less whining.  When I read this article, I had one of those moments.  Continue reading “A Message in a Bottle”

How to Say “No” to Your Boss

August 29, 2013

Unless you’ve been living on a deserted island, you’ve probably heard about the exploits of my now former mayor, Bob Filner. The most notorious were the allegations by numerous women  of various forms of inappropriate flirting, sexual harassment and possibly even assault. Less provocative, but also quite disturbing, were reports of improper demands for financial concessions from developers and the misuse of a city credit card for personal expenses. Continue reading “How to Say “No” to Your Boss”

Personal Finance Tools for Busy Parents

August 26, 2013

The dog days of summer are here and it’s back to school time for millions across America. To a certain degree, I actually enjoy the routine of the school schedule.  Like the changing of seasons, there is a sense of familiarity despite the unknowns of what may happen along the journey.  Continue reading “Personal Finance Tools for Busy Parents”

Can Your 401(k) Be Part of Your Emergency Fund?

April 11, 2013

One of the results from our recent research report that has gotten a lot of attention is that we saw an increase in the number of employees’ accessing their 401(k) balances through loans and hardship withdrawals from about a quarter in 2011 to about a third in 2012. The conventional wisdom is that this means employees need to do a better job with money management and in particular, building an emergency fund of at least 3-6 months of necessary expenses and maybe even more. For someone just starting out, I think this is absolutely true.  Continue reading “Can Your 401(k) Be Part of Your Emergency Fund?”

Why Disability Protection is So Important

April 03, 2013

Several weeks ago, my brother was working on some routine plumbing around the house when he bent over to pick something up.  As he straightened up, he heard a “pop” and felt a sharp pain in his knee.  Immediately, he knew something was wrong, and a quick trip to the emergency room confirmed what he had expected: he tore his meniscus.  Within a few days, my brother had surgery performed to repair the damage and for the next six to eight weeks he will be unable to put any pressure on his leg.  Continue reading “Why Disability Protection is So Important”

Money Tight? Make it Work Harder For You

March 11, 2013

Last year, employees got a break, a 2% bump in their take home pay, thanks to the payroll tax holiday enacted by President Obama to try to boost the economy in 2011- 2012.  The employees’ share of Social Security taxes were reduced from 6.2% to 4.2% for a time.  Like all good things, it came to an end and now employees are feeling the squeeze. Continue reading “Money Tight? Make it Work Harder For You”

How To Have Too Much Cash

March 04, 2013

Cash is king. You hear that term being thrown around and for good reason – having available cash is vital to financial health. Without having a cushion of cash, you are very vulnerable and can easily be taken advantage of during hard  times.  When you have a solid emergency fund with enough funds to carry you for six to eight months, you can handle most emergencies — even a job loss– with out having to take extreme measures. Continue reading “How To Have Too Much Cash”