If you’re just starting out, you may be put to the decision of whether you should fund your retirement accounts or fund your emergency fund. In order to answer this question, you need to have a grasp of your total financial picture and you can do so by asking yourself the a few questions.
Does your employer offer a 401(k) match? If your employer offers a 401(k) but does not offer a match, the smart money would likely fund the emergency fund first. If your employer does offer a match, contribute as little as you need to in order to receive the maximum match. If your employer gives you 50 cents on the dollar up to 6% of your salary, contribute 6%. Then you should put additional savings into an emergency fund.
It seems like the only question you need to ask yourself is whether the employer offers a match right? Wrong, that’s just the first question. After you achieve the maximum match, you can’t really screw yourself up too much because you’ve already gotten the low hanging fruit.
How much should you put in an emergency fund? The advice generally ranges from 3 months to a year of expenses but I recommend hedging your bets at around six months and then moving funds into a Roth IRA if you are eligible. If not, the 401(k) may be a good second place.
Usually emergency funds are designed to handle events that are less than or equally catastrophic than a job loss, hence the metric of using expenses as a gauge. For events that are more catastrophic, such as a medical emergency, should be taken care of by your insurance coverages (if they aren’t, you should get some insurance). So, six months is a good mean period to be out of work if you’re let go, assuming you get zero severance, because you give yourself ample time to 1) find an equally paying job; 2) cut expenses to compensate for loss of income; 3) find a lesser paying job to cut the drain on your emergency fund.
Have you fully funded your 401(k) and IRA? If so, consider boosting your emergency fund to a full twelve months and then start laddering them in certificates of deposit so you’re getting more than a piddly 0.5% (or less) in interest. This will ensure you have access to a month’s worth of fund (or more depending on how you ladder them) to cover any emergencies you do face. If you do lose your job, the CDs will mature in time for you to need them. If you encounter a major event that’s more than a month’s expenses, you can always float yourself the funds via a credit card.