If you want to know why you need to have (and possibly use) an emergency fund, you need just go as far as defining “emergency.” To paraphrase online definitions -- it’s a dilemma, a hard time, a bump in the road. It’s anything that disrupts the flow of money coming into your household (your income) or requires a “fix” that exceeds the money you have on hand.
Experts often say that reserving four to six months’ expenses in a savings account as an emergency fund will help you combat unforeseen disasters. But why?
The timeline of an emergency
"Emergency" could be applied to many situations: job loss, prolonged periods of illness, hurricane, flood, fire, tornado, etc. You stop receiving a paycheck. You can’t get out of bed to take care of life’s odds and ends: cooking, cleaning, driving the kids to soccer. Your roof has a hole in it, or your basement becomes a giant lake.
Even a lesser emergency like a furnace or water heater breakdown can mean having to pay out money unexpectedly. Is your refrigerator kaput? That’ll be $200 to $2,000 (or more) to replace. If you are living paycheck to paycheck, you might not have cash on hand to buy household appliances that break. An emergency fund kicks in when you don’t have enough coming in to cover what is going out.
However, emergency is a temporary state. Emergencies are sudden and urgent. When they last longer than six months, they graduate to circumstance. That’s when you might want to rely on other financial conventions for relief: disability insurance, homeowner’s insurance, downsizing your expenses or increasing your debt. An emergency should not eclipse your entire life, forever.
Lost your job and looking for a new one?
The United States Department of Labor, Bureau of Labor Statistics reports rates of job loss due to discharge or layoff Opens in new window at roughly 1.5 million to 2 million jobs per month, across the whole of the U.S. in 2016. Even though new jobs are being created all the time (at an average of roughly 5 million jobs per month Opens in new window in 2016), it can take four to six weeks – or even longer – to fill a new job opening. That means that you could spend that amount of time on each job for which you are a serious contender.
Job hiring times vary widely by industry and region. Generally speaking, one can collect unemployment benefits for up to 26 weeks (or six months), but that number varies by state. In essence, unemployment is a de facto emergency fund. The standard payout period was developed to cover unemployed people for long enough to acquire a new job. Keep in mind that unemployment benefits will only cover up to 60% of your earnings Opens in new window, as assessed from your base period (the first four of the last five calendar quarters that directly proceeded the date of your claim).
If you find yourself out of work for longer than six months, you might need to consider alternative employment options by changing jobs or going back to school. You might draw upon your emergency fund to pad unemployment benefits or help pay for vocational training.