An Easy Formula for an Emergency Fund

Figure out how much cash you should put away.

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How much money should you have in short-term savings in case you lose your job or some unforeseen disaster strikes? I've heard everything from a couple of thousand dollars to three or six months' living expenses—and I even know someone who, until recently, had $20,000 set aside for a rainy day.

Fellow blogger Money Under 30 shares his formula for figuring out how much money you should set aside in an emergency fund:

Calculate your minimum monthly expenses: These are fixed expenses, such as rent, utilities, auto and student loans, and groceries.

Score your income volatility: If you have a full-time, permanent job that pays a set salary each month, give yourself an income volatility score of 1, says Money Under 30. But if you're self-employed or work as a freelancer, figure how much money you made in each of the past 12 months and choose the months in which you made the most and the least. Subtract the lowest month's income from the highest and divide by the former to get your income volatility score. He gives the following example:

$7,800 (high month earnings) - $2,200 (low month earnings)/$2,200 (Low month earnings) = 2.5 (income volatility score)

Score your income "commutability": If you lost your job tomorrow, this score represents how long, on average, it might take you to find a job that pays a comparable salary. Take the number of years you've been working and multiply by 0.5, then add 0.5 for every $10,000 you earn annually over $40,000. Money Under 30's example: If you have worked for five years and earn $60,000, your score is 3.5.

Calculate your liquid savings: Add up any money you have stashed in a savings or money-market account that you could access in an emergency. Don't include retirement accounts.

Once you've worked out the math above, plug it into Money Under 30's formula: take your minimum monthly expenses and multiply by your income volatility score, then multiply that number by your income commutability score. Finally, subtract your existing savings. Here's his example:

If your minimum expenses are $2,500 a month, you work a permanent, salaried job, have been working for five years, earn $50,000 annually, and have no prior savings; your emergency fund should contain at least $7,500.

He points out that this formula is based on simple experimentation. It's designed to give you a rough estimate.

Tell me, after applying this formula to your own situation, do you have enough money for an emergency fund?