Why You Need An Emergency Fund: A Real Life Experience

Working as a management consultant you get to try different types of projects in different industries.

Over the past few weeks, I tried my first cost out project. If you are not familiar with the concept, it involves reducing costs in a business.

Unfortunately, in this case, it involved the planning of laying off several hundreds people.

This was the first time I tried working on such a project, and I’m not going to lie: it was extremely hard.

Not only is it an extremely difficult problem to solve, but the thought of the families it will impact is the hardest.

It taught me two lessons:

  1. Capitalism doesn’t care about you
  2. You need an emergency fund!

Capitalism doesn’t care about you

You probably won’t be surprised by the fact that (most) business don’t exist to make you happy.

Businesses exist to make their shareholders money.

Having worked in several, large multinational companies, this is the main driver of everything they do.

Business people will argue that if they don’t cut costs, the entire company could go bankrupt. This would result in a much worse scenario where everybody lost their jobs.

While there is some truth to this statement, it is not always the case.

Regardless, this is bad news for all of us with a job. We are constantly at risk of losing our jobs.

I promise you, most of the people being laid off as a result of our project will not see it coming.

So what can we do to be ready for the unexpected?

You guessed it…

You need an emergency fund

Sometimes unexpected things will happen. You might lose your job. You might get sick.

This is why you need an emergency fund. Exactly because of these events. Emergencies.

An emergency fund is an account with funds set aside for emergencies. You can only use money from the emergency fund if you become sick, lose your job or something similar.

Once you have an emergency fund, you and your family are less likely to experience unsolvable emergencies.

The median US household has savings of $4,830 in savings and 40% of US adults cannot cover a $400 emergency.

You see how dangerous it can be not to have some cash set aside to afford even a $400 emergency?

Now, I really hope that the families affected by my current client’s decisions have an emergency fund. Most likely, not all of them will have money set aside. That makes me tremendously sad.

On the positive side, I live in a welfare state where people get a small amount to cover necessities and help to get a new job if they are fired. You can still have emergencies and need cash set aside even though you live in a welfare state.

Globally, the welfare state is the rare exception and not the rule. That’s why most people need an emergency fund if they want to add a safety net to their lives. This way they are less prone to experience a disaster in case of an emergency.

How much money should you have in your emergency fund?

Determining how much money you should have in your emergency fund is a matter of your risk appetite.

A good rule of thumb is to have at least three months of living expenses in an emergency fund.

If you know you can easily get a job in a matter of weeks, you probably don’t need that much. However, if it could take you half a year to get a job, you should probably aim for cash enough to cover six months of living expenses instead.

Most people pursuing financial independence will quickly have enough money to cover three months living expenses. Most would also have this money invested.

Should you invest the cash in your emergency fund? As a rule of thumb, probably not. Markets can crash when you need the cash. Often market crashes are correlated with people losing their jobs.

Personally, we keep roughly two months of expenses in cash for emergencies. We do this because we both have well-paid jobs and skills that are in relatively high demand. Also, we don’t mind the risk as much.

Your turn: Do you have an emergency fund? Why (not)?