5 Steps Reveal the Right Amount of Ready Cash For You

2. Subtract what’s optional

The goal here is to plan for an interruption in your income, or what’s known as a supply emergency. (The other major type of emergency is a demand emergency: a large, unexpected expense.)

To plan for a supply emergency—losing your job, for example—you need to know how much money you would need to get by each month. To do that, divide you list of expenses into those that are essential rent, food, medicine) and those that are not (streaming services, alcohol, various memberships). Making that distinction is a personal process. Would you cut back on giving birthday presents? Haircuts? Vacations?“Some people say Netflix is pretty essential,” says Dana Levit of Paragon Financial Advisors in Newton, Massachusetts. Be honest with yourself about what you can and can’t bear to give up. Subtract what's cuttable from your monthly spending. The result is your monthly number for getting by.

3. Decide how many months you’ll cover

Once you know how much money you would need per month in a supply emergency, consider how many months you think it would take to get your income going again.

While there is no simple formula for determining what’s right for you, a minimum of three months of living expenses is a good starting point. As of last December, about two-thirds of the unemployed population had been out of work for up to 14 weeks, a number that has stayed relatively constant over the past year. If you are disabled, it can take at least three months before you can begin to collect disability insurance. Whatever number of months you decide on, multiply that figure by the amount of money you need per month to get by during a supply emergency. That’s how much money you need to be safe.

4. Budget for surprise expenses

Now let’s consider demand emergencies—a broken major appliance, for example, or a trip to the ER. If you have enough money in the bank to cover a few months of lost income, you probably have enough to cover a sudden expense as well. A 2020 academic paper written in collaboration with AARP found that having $2,500 in a bank account correlated with a lower chance of financial distress years later. Bottom line: It’s up to you whether you want to add extra money to your safety cushion from Step 3 to cover potential surprises. But if a surprise expense comes along, you’ll want to replenish the amount you took from your reserve and bring it back up to a safe level.

5. Prepare for big non-surprises

An expense that’s out of the ordinary isn’t necessarily unpredictable. Perhaps you would like to take a vacation or buy a new car. Things will go more smoothly if you start putting money away—separate from your emergency fund—so that when the time comes to open your wallet, you don’t have to borrow at short notice or sell investments when markets are down.

Think of these funds as separate from an emergency fund—a “liquidity bucket,” in the words of Anthea Perkinson, who operates Monterey Associates, a financial planning firm in Pelham, New York. Your goal with such funds is to make sure that money is available when you need it.

Don’t despair if having three months’ worth of living expenses on hand seems like an impossibly high bar. You’re not alone: Only about 4 in every 10 Americans have enough savings to cover an unplanned expense of $1,000, according to a recent survey by Bankrate.

You can build up your cash reserve bit by bit. “Start small and remember that every dollar saved can cover some kind of emergency,” says Pugh of Creative Planning. She cites the example of a woman she was advising who had managed to set aside just $100 in her emergency fund. Soon afterward, when the battery in the woman’s car died, that $100 in the bank—enough for a new battery—sure came in handy.