DEAR DAVE: I'm following your plan, and currently I have $14,000 in my emergency fund. What are essentials for three to six months of expenses?
DEAR BRIAN: Basically, you should ask yourself this question: “What would it take to operate my household for a month?” There are several different things that could be classified as “essentials,” but if you take those things and multiply the number by three, four, five or six, you'll see how much money you need to have a fully loaded emergency fund of three to six months of expenses. This is Baby Step 3 in my plan.
Some people get really technical about exactly how many months of expenses they need to save in this range. And that's OK. You can take a little time to evaluate things before moving on to Baby Step 4, which is investing 15 percent of your household income into Roth IRAs and other pretax retirement plans.
Believe me, it's a great feeling to have a big pile of cash sitting there just for a rainy day. You don't want to go nuts and make it so big that you sacrifice retirement or other important aspects of your life, but after a point you shouldn't be too concerned whether you have three months or six months of expenses — or somewhere in between — saved just for emergencies.
Having a nice emergency fund, along with no debt, creates a wonderful sense of financial peace.
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