Many experts say that you should set aside anywhere from three to six months worth of expenses in case you lose your job, incur hefty medical costs or otherwise find yourself unexpectedly short of cash.
Having a rainy-day fund to fall back on is especially important these days, given the state of the economy and the job market. But while most people understand the importance of a rainy-day fund, figuring out how to set that money aside can be tricky.
Thanks to heightened inflation, most budgets are so tight that squeezing out a few hundred extra dollars each month is a big challenge -- much less finding enough cash to last three to six months.
Consider how long it will take for you to reach your target rainy-day amount at your current savings pace. The Emergency Savings calculator from BankingMyWay.com can help you figure out how long it will take before you've compiled an adequate emergency cache.
The calculator starts by helping you estimate how much you actually need to set aside.
You will need to input your monthly living expenses and the number of months that you want to cover (remember that experts suggest three to six months). The calculator also asks you to estimate how much you may have to pay in terms of emergency bills, such as medical, legal, insurance deductibles and even property damage.
You also need to enter your expected rate of return (these days the average money market fund ranges from around 0.4% to 2% depending on your state, according to BankingMyWay.com), as well as your state and federal tax bracket -- unfortunately, any interest you earn on your emergency fund is taxable.
Last, you enter the amount you are starting with, and the amount you think you can manage to set aside each month. The calculator will report how long it should take before you reach your target amount.
For example, say you have monthly expenses of $2,500 and you want to set aside five months' worth. You estimate that you may need to cover $3,000 of emergency medical and auto repair bills and around $500 worth of insurance deductibles in case something bad happens. In order to cover the above expenses, you'll need to set aside a total of $16,000.
Let's say you have managed to save up $1,000 already, and you can squeeze an extra $250 a month out of your budget. According to the calculator, you'll reach your emergency savings target in four years and 10 months (assuming an average 2% rate of return and 25% federal and 8% state tax brackets).
You can shorten that time frame significantly if you can squeeze more out of your budget -- even an extra $25 to $50 each month. Setting aside $275 a month instead of $250 shaves five months off your target date. Saving $300 a month would drop another five months, meaning you'd be set after just four years.
Once you have reached your target amount for your emergency fund, you'll be more secure in the event of an emergency -- and you'll have room in your budget to start saving for other things. With your emergency fund safe and sound in a low-risk account, you can start investing that $250 a month toward retirement, a college fund, your next home -- or any other priorities you have.