An emergency fund is an allotted amount of money that you've saved for a rainy day. This means if you lose your job or incur a significant one-time expense, you'll be able to weather the storm and survive financially.
You might think the more you have saved for your emergency fund the better it is. Well there lies the dilemma. Too much saved and you are foregoing the investments
you could have made with that money. Not enough money in your emergency fund and you run the risk of running out of money when an emergency arises.
"The general rule for an emergency fund is to save anywhere from three to six months of living expenses."
Saving your money in an emergency fund is similar to that of paying car
insurance. The best way is to take a portion of your paycheck and set that amount aside for the emergency fund. But, where do you cap out? How much is too much?
While how much you decide to ultimately save
in your emergency fund is a function of your risk toleration and income to expense ratios, the general rule is to save anywhere from three to six months of living expenses. If you have a family to support or people who depend on you financially, you might lean towards the six months versus the three.
The best way to determine how much you should save in your emergency fund is by asking yourself if you lost your job, how long would you be without one. In some industries, it may take a couple weeks to find another job
. In others, it can take up to a year. That would be your basis from where you would determine how many months you need to save up for. If you have multiple streams of income, the likelihood of all of them failing to produce is lower than just any one stream coming to a halt. Therefore, you might have a higher tolerance for a lower emergency fund.
Ultimately, how much you decide to put in your emergency fund is how comfortable you are with the worst case scenario occurring (losing all revenue streams) and the probability of that happening. If you have a high risk tolerance and believe there is a low probability of you losing your income streams, then you can have a lower emergency fund. On the contrary, if you are the opposite, then you should have more money in your emergency fund.