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Financial Goals

Funding a Safety Net: Calculate Your Target Amount

Betterment’s safety net guide and this simple formula could mean all the difference in an emergency.

Articles by Dan Egan

By Dan Egan
Managing Director of Behavioral Finance & Investing, Betterment  |  Published: August 6, 2013

An emergency fund should contain enough money to cover your basic expenses for a minimum of several months.

Consider this simple formula: Monthly expenditures x Re-employment period = Baseline safety net amount.

A fundamental of good personal finance is to have a backup plan—or a stash of money that will buffer you against the bigger knocks in life, such as an unexpected personal expense or a loss of your primary source of income.

This backup is your safety net fund, and it should be a somewhat liquid account that you can access on a few days’ notice.

But how much do you actually need to set aside in your safety net fund? Much of that depends on your monthly essential expenditures. There is no perfect answer, but here’s a guide that you can personalize to get an amount that’s right for you. We’ve also provided some tips and a formula for you to calculate your very own safety net amount.

Use Our Guide to Estimate Your Safety Net Amount

We can calculate a quick safety net fund amount for you by using similar methodology used in RetireGuide, Betterment’s retirement planning tool.

For our safety net advice, we use your monthly gross income, data from the average cost of living index, and then adjust for taxes, as well as your propensity to save or spend.

We then multiply this figure by three months of anticipated loss of income and add a 30% buffer on top.

Our Formula Explained

First, your gross income can help us estimate your after-tax income.

While your pre-tax savings in Individual Retirement Accounts (IRAs), 401(k) plans, and other personal deductions might impact our estimate, we don’t anticipate that it will be material. We use these variables because there is a strong relationship between your pre-tax income and how much you’ll be spending each month.

Next, we use your income and data from the average cost of living index to estimate how much we think you will spend each month—this is known as a “marginal propensity to spend”.

These combined numbers allow us to estimate your three-month baseline safety net fund. After we determine this amount, we add our 30% buffer.

For any given income level, we calculate tax, and then also estimate how much we think you should be saving.

Now, Calculate Your Safety Net Fund Amount

You can calculate your own safety net fund amount with a simple formula:

Monthly expenditures x Re-employment period = Baseline safety net amount

Here’s how to figure out the first two parts of the equation.

First, Consider Your Monthly Expenditures

Ideally, you should have an estimate for the smallest amount of money that you’d be able to live off of, month-to-month.

That includes your total bills and expenses for the following essentials, such as: housing, utilities, loan payments, food, clothing, transportation, and health insurance.

You’ll want to add those up to get the sum of your total monthly expenditures.

Then, Estimate Your Re-Employment Period

A safety net fund can cover you in case you lose your primary source(s) of income, so you need an idea of how long you might be without that income.

One way to estimate how much you might need is to multiply your monthly minimum expenses by your re-employment period (the number of months it might take you to find a new job).

According to September 2016 data from the Bureau of Labor Statistics, the average duration for unemployment in the United States was 27 weeks. You can customize that timeframe based on your industry and skills.

While our formula uses re-employment period as the period of time for which to build a safety net fund, there are of course many other circumstances aside from job loss, such as personal leave, medical expenses, or gap years, which will warrant a different time period estimation.

In general, it is a good idea to have a minimum of three to six months of monthly expenses covered in your safety net fund.

If you can fully fund your baseline safety net, then you may wish to consider creating a safety net fund that is even larger than this amount and investing that money.

Consider the following chart, which is based on data for a Colorado resident.

chart percent of income vs pre-tax

Data: Betterment analysis of self-reported income and estimated tax rates; American Economic Association; National Bureau of Economic Research. The chart shows assumed rates of spending, savings, and effective taxes for a single individual with no additional information about location, actual savings, or Social Security beneifts. The default location is Colorado, which is roughly equivalent to the U.S. national average for cost of living and state taxes.

Betterment encourages people who earn more to save more. Of course, the number derived from an estimate is just that, an estimate. If you can calculate your monthly spending needs using the more personalized method, you’ll likely reach a more precise amount.

For those who have not yet saved for a safety net fund, Betterment’s advice can tell you exactly how much you need to save every month to meet that target over the next three to five years. For example, if your goal is to save $20,000 in three years for a safety net, Betterment suggests a monthly deposit of $521.86 to get you there.

Of course, you should always keep a small reserve of cash on hand for immediate emergencies. But if you plan to keep a safety net fund in place over the long term, investing that money might be a smarter choice as cash will likely lose its value due to inflation.

1Suggested monthly deposit based on Betterment’s default safety net advice with zero initial deposit, which recommends an asset allocation of 40 percent stocks. Returns are subject to the disclosure found here.

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