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Use your total salary, including bonuses and commissions, as your base figure. Multiply your monthly take-home pay by at least three months if you are in a thriving profession. However, the cautious option is to pursue at least six months of savings to give enough time to find a new job.
Total all your monthly bills. This includes fixed costs, which remain the same amount each month, and variable costs, which consist of bills that come in every quarter, six months or once a year. Fixed costs include the COBRA cost for the medical insurance provided by your employment, rent, food, credit card payments, car loan, cable and loan payments. Variable costs include insurance payments, car registration or property taxes. Estimate the amount of entertainment expenses to include eating in restaurants, going to the movie or concert, new interview clothes or other items. This provides you with your total monthly debt that your emergency fund will
be required to cover each month.
Although there are several different theories on the savings amount, the traditional view for the amount in an emergency fund is three to six months of your current salary, as this should provide a financial cushion until you are rehired. However, another theory advocates having one month of your salary available in cash, while the other months are invested in the stock market earning money. One additional theory suggests that placing $500 in a savings account for an emergency fund is sufficient as you pay down debt and build your retirement fund.
Although you may be tempted to use your retirement fund as your emergency fund, this can be a foolhardy idea. Several retirement accounts include an IRA, Sep-IRA, Roth IRA or 401k. Most withdrawals from a retirement fund carry a penalty. Additionally, the IRS considers early withdrawals to be income, and you would be required to pay taxes on it.
Category: Personal Finance