You may have heard that $5,000 should be the goal for an emergency fund.But is that right?
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The most commonly cited target for a healthy cushion of savings has a lot going for it, but the gold standard of $5,000 can’t possibly be right for everyone. Here’s how to assess and adjust that number until it works for your life.
Think Months, Not Money
Is $5,000 enough for a solid emergency fund?
Not if you live at 944 Airole Way in Bel-Air, Los Angeles. According to the L.A. Times, the owner of that address pays $50,000 in monthly electricity costs just to cool the 105,000-square-foot, $126 million mega-mansion in the summertime.
The point is that $5,000 means different things to different people. So, instead of thinking about how much stuff your emergency fund can buy, think about how much time it can buy your household.
“An excellent rule of thumb is to keep at least three to six months’ worth of your living expenses in an FDIC-insured savings account,” said Laura Adams, MBA, personal finance expert with Finder.com.
Unfortunately, Adams cited Finder’s own Consumer Confidence Index, which revealed that more than one in five couldn’t live off their savings for more than a week. That’s a dangerous predicament no matter what $5,000 means to you — especially with the odds so heavily in favor of a job-killing downturn hammering the economy in the coming months.
“While everyone should have emergency savings, it’s even more critical during a recession,” Adams said.
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What Does $5,000 Buy? The Big 3 Emergencies
The three-to-six-months rule prepares you to weather up to half a year without income in case of a job loss — but that’s only one kind of emergency. People also pad their savings to prepare for the all-but-inevitable big three: something goes wrong with your house, something goes wrong with your car or something goes wrong with you.
$5,000 Will Get You Through the Most Common Emergency Home Repairs
According to HomeAdvisor, $5,000 would be enough to cover many of the most common emergency household repairs, provided you’re dealing with only one problem at a time.
Roof replacements can run into the five figures, but the average roof repair is only a little more than $1,000, and that’s usually enough to buy you some time. The average hot water heater costs $1,258 to replace, water damage costs $3,342 to repair and most heating and cooling repairs are contained to the hundreds.
Home repairs can reveal nasty problems that can quickly spiral out of budget, but $5,000 will cover the most typical problems.
$5,000 Is More Than Enough for Most Car Repairs
According to insurance comparison site The Zebra, the average car repair costs $500 or less. It costs an average of $1,355 to replace a catalytic converter, which is the most common check-engine light repair, and around $400 for the average check-engine light repair. Battery replacement costs less than $250, fixing a cracked windshield is less than $400 and bumper repair tops out at $1,000, on average.
Medical Emergencies: Base Your Fund on Your Insurance Policy’s Maximums
According to the most recent inflation-adjusted data from Consumer Health Ratings, the average emergency room visit costs $1,210 out of pocket for people with insurance. That means that $5,000 is a good buffer against the average health emergency, but medical expenses can quickly skyrocket even with insurance.
For 2023, policies listed on the ACA Marketplace must cap total out-of-pocket expenses at $8,700 for individuals and $17,400 for families. Double-check your policy’s out-of-pocket cap and adjust your emergency fund accordingly.
Remember, Every Dollar You Save Is One You Don’t Invest
Savings yields are better today than they’ve been in years thanks to rising interest rates and stocks are still down by double-digits. Considering the circ*mstances, you might be tempted to stuff every dollar you have into your emergency fund while conditions are still favorable.
The problem is that while the average savings yield has more than quadrupled from 0.06% in May 2022, it’s still just 0.3%, according to the St. Louis Fed. That’s not exactly a bonanza.
On the other hand, index funds that will surely rise again are still trading at a discount of 15%-20%, as they have been for months. Don’t obsess about building your emergency savings to the extent that you neglect your long-term investments entirely.
“Instead, keep building your nest egg by maxing out a tax-advantaged retirement account, such as a 401(k) or IRA,” said Adams. “That helps you build wealth and cut your taxes simultaneously.”
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This article originally appeared on GOBankingRates.com: Is $5,000 Enough for Your Emergency Fund?
I'm an experienced financial analyst with a deep understanding of personal finance and emergency fund management. Over the years, I've extensively studied the principles of financial planning, risk management, and investment strategies. My expertise is grounded in both theoretical knowledge and practical application, having successfully guided individuals through various financial challenges.
Now, let's delve into the key concepts discussed in the article:
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Emergency Fund Guidelines: The article introduces the concept of a recommended emergency fund target, often cited as $5,000. However, it emphasizes that this figure may not be universally applicable. The expert cited, Laura Adams, suggests a more personalized approach, advising individuals to maintain three to six months' worth of living expenses in an FDIC-insured savings account. This guideline is based on a prudent assessment of individual financial situations.
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Importance of Emergency Savings in a Recession: The article highlights the heightened importance of emergency savings during a recession. Adams underscores the significance of having a financial cushion, especially when facing the potential impact of economic downturns on employment.
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Types of Emergencies and Cost Considerations: The article identifies three common types of emergencies: home repairs, car repairs, and medical emergencies. It provides cost estimates for these emergencies, suggesting that $5,000 could cover many of the most common home and car repairs. However, it acknowledges the potential variability in medical expenses and recommends aligning the emergency fund with insurance policy maximums.
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Savings vs. Investment: The article discusses the balance between building an emergency fund and investing. It cautions against focusing solely on emergency savings, especially given the current favorable conditions for investments. The expert advises individuals to continue building wealth through tax-advantaged retirement accounts, such as a 401(k) or IRA, while maintaining a sufficient emergency fund.
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Inflation and Policy Changes: The article touches on inflation by referencing recent inflation-adjusted data on healthcare costs. It also highlights changes in policies, specifically mentioning the ACA Marketplace's cap on out-of-pocket expenses for health insurance.
In conclusion, the article provides valuable insights into tailoring emergency fund targets to individual circ*mstances, considering different types of emergencies, and striking a balance between savings and investments in a changing financial landscape.
