If you have searched the internet about Financial Freedom you have come across the concept of Emergency Funds. Ideally, this is around 3 to 6 months of your monthly income or expenses.
An Emergency Fund is an amount of money that you set aside in case you lost your income. It also acts as a buffer to avoid touching savings or investments during emergency expenses.
Most of the books and internet articles we read says that it should be based on monthly income, there are a few that says it should be based on Monthly Expenses.
READ: You can also check out Why You Should Have an Emergency Fund
Should an Emergency Fund be based on Monthly Income or Expenses?
Just like any other Financial Freedom concept, an Emergency Fund does not have a hard rule on how much it should be and what it should be based upon. It really depends on the individual or family’s needs. Some people base it on their income while some base it on the monthly expense.
For our family, we decided to base it in our Monthly expenses and below are the reasons why.
Varying Multiple Streams of Income
We have multiple streams of income. My day job gives me a constant amount of income per month and other streams of income changes monthly. If we were to base our Emergency Fund on the income, we will not be able to know which month to base it on since I do not have fixed monthly income.
What if I get an increase? Then I need to catch up again to reach my 6 months of monthly income to reach my target Emergency Fund, right?
Why Do We Need an Emergency Fund
The reason for an Emergency Fund is to have buffer fund in case of the loss of an income. This fund will cover all expenses you need in order to survive while you are still looking for an income. “If I were to lose my job, how many months can I survive without an income?” is the question to ask when we check the status of our Emergency Fund.
How To Survive Months Without Income
If you answer this question, ideally you will have to come up with another question “How much do I need each month to survive?” Hence why we base our Emergency Fund on our Monthly Expenses.
The Monthly Expenses should include rent/mortgage, payment for monthly bills, grocery budget, and any bills to pay or set aside money for in a monthly basis. So in the case that there is income loss, we will still be able to cover all your financial obligations until we get a new job.
As long as we are able to raise 3-6 months worth of Monthly Expenses, we will be able to survive 3-6 months without income and not touching any of our Savings or Investments.
Living below our means
Let us say that my monthly net income is ₱30,000 and my monthly expenses is ₱20,000.
If my Emergency Fund is 6 months of my monthly income then that would amount to ₱180,000.
If the Emergency Fund is based on monthly expenses then our goal would be to reach ₱120,000. A much lower and easier amount to reach compared to basing it on monthly income.
Having your Emergency Fund based on Monthly Expenses is easier to reach and less complicated since it does not change regularly, it is still better to have a bigger Emergency Fund.
The bigger your Emergency Fund is, the longer you can live without an income.
Currently, my wife and I have an Emergency Fund amount up to more than 6 months of living expenses. We do not plan to stop there, next goal is 8 months, then 10, then finally to reach 12 months to give us financial security should we need it. This gives us peace of mind knowing that our family will be able to survive even if we lose our income source and we will have enough time to find another job if that happens.
Do you base your Emergency Fund on Monthly Income or Monthly Expenses? Let us know in the comments below.