Figuring out the ideal amount for building an emergency fund is a puzzle many need help solving. According to the usual rule of thumb, setting aside three to six months’ worth of expenses in your emergency fund is wise, but there are exceptions where saving 12 months’ worth is recommended. In this blog, we will explore an age-based approach to emergency funds.
Understanding the Age-Based Approach to Emergency Fund
This approach considers age a primary factor in determining the amount required in the emergency fund. The underlying assumption of this approach is that different life stages and financial situations require different levels of financial protection.
Let’s consider two individuals, Ananya and Sunil, who work in the same firm and hold the same designation. Ananya is 25 years old, while Sunil is 44 years old. They have similar salaries and expenses, but their different life stages will influence their approach to emergency funds.
Ananya’s Situation:
- Age: 25 years
- Monthly Income: ₹50,000
- Monthly Expenses: ₹30,000
- Debt: None
- Health Insurance: Provided by the employer
- Dependents: None
- Job Stability: High, as the company has been performing well, and layoffs are unlikely.
Considering Ananya’s young age, stable job, and lack of significant financial responsibilities, the Age-Based Approach suggests having an emergency fund of 3 to 6 months’ monthly expenses. Since Ananya’s monthly expenses are ₹30,000, her ideal emergency fund size would be between ₹90,000 and ₹180,000.
Sunil’s Situation:
- Age: 44 years
- Monthly Income: ₹50,000
- Monthly Expenses: ₹30,000
- Debt: Home Loan with a balance of ₹15,00,000
- Health Insurance: Provided by the employer (but may have higher medical expenses due to age-related concerns)
- Dependents: Spouse and one child in college
- Job Stability: Moderate, as the firm has been facing some challenges, and layoffs have occurred.
Sunil’s situation is different from Ananya’s. At 44, he has additional financial responsibilities, including a home loan, family support, and potential medical expenses due to age-related concerns.
The Age-Based Approach recommends a larger emergency fund for Sunil to account for these additional responsibilities. The guideline suggests having 6 to 12 months’ monthly expenses as an emergency fund. Since Sunil’s monthly expenses are ₹30,000, his ideal emergency fund size would be between ₹180,000 and ₹360,000.
Typical Situation at Different Ages and Recommended Emergency Fund Size
1. Age: 25 years or younger
Typical Situation:
- Renting a home or living with parents
- Minimal financial responsibilities
- Fewer or no dependents
- Lower income and job stability concerns
Recommended Emergency Fund Size: 3 to 6 months’ worth of monthly expenses
2. Age: 25 to 35 years
Typical Situation:
- Renting or owning a home
- Higher-income and career stability are improving
- Starting a family and increasing financial responsibilities
- Student loans or other debts may be present
Recommended Emergency Fund Size: 6 to 9 months’ worth of monthly expenses
3. Age: 35 to 45 years
Typical Situation:
- Established career and higher income
- Owning a home and supporting a family
- Saving for children’s education and retirement
- Potential health-related expenses for a family or ageing parents
Recommended Emergency Fund Size: 9 to 12 months’ worth of monthly expenses
4. Age: 45 years or older
Typical Situation:
- Peak earning years but facing higher expenses
- Supporting children’s education or elderly parents
- Closer to retirement and prioritising financial security
- Planning for a secure financial future during retirement
Recommended Emergency Fund Size: 12 to 24 months’ worth of monthly expenses
Final Words
In conclusion, we can say that an emergency fund provides crucial protection against unexpected events. While most financial experts recommend having three to six months’ monthly expenses in an emergency fund, an age-based approach is more personalised.
Younger individuals with fewer responsibilities may find three to six months’ expenses adequate. In comparison, those in their peak earning years or with higher financial obligations might benefit from saving up to twelve to twenty-four months’ worth.
Remember, financial security is a journey, and building a well-calculated emergency fund is a significant step towards a stable and resilient financial future.