Planning Your Emergency Fund

The graph above shows the value of an individual’s emergency fund expressed in the number of weeks worth of expenses vs. the percentage likelihood of having an emergency  that would wipe it out.  It starts at 100% with no emergency fund and works down to about 3% at 52 weeks worth of expenses in reserve.

Given various emergency fund sizes,following are the probabilities of having emergencies that would wipe out the emergency funds and the frequency of such incidents.

  • 0 weeks = 100%, guaranteed to have problems
  • 4 weeks or 1 month = 70% or every 17 months
  • 8 weeks or 2 months = 49% or every 2 years
  • 13 weeks or 3 months = 31% or every 3 years
  • 26 weeks or 6 months = 10% or every 10 years
  • 52 weeks or 1 year = 3% or every 33 years

Now you are in a better position to decide how much insurance you can purchase with the cash you set aside for emergencies vs the opportunities you lose by not putting the money to use.

Here are some thumb rules on the size of emergency funds that are recommended for people depending on their source of income:

Personally I believe that the emergency corpus should be bigger for entrepreneurs.My preference is a corpus to cover expenses till the estimated break even time plus 2 to 3 years expenses.And if you have more than one new or growing business then the corpus needs to cover the risks rising from each business.Remember all your businesses can sometimes have problems simultaneously.

And even if you are wealthy enough to live off your investments,I still think you need an emergency funds.No one is immune from income disruption or loss.

If all this sounds like a waste of good money why not think of it like this?You will not require all your emergency money at once so why not keep them in fixed income instruments that generate better returns?Just clearly label them as emergency funds and don’t dip into them.One of my goals in life is to generate maximum wealth in my lifetime and leave an inheritance for my family.So I choose to assign any unused emergency funds to my legacy account to create emergency funds a generation ahead.

About Keerthika Singaravel

2 Responses to Planning Your Emergency Fund

  1. Alex Jones says:

    My local council has a reserve fund for emergencies, why not individuals? Good post.

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