12-Month Emergency Fund: Is It Too Much or Just Right?

Is having a 12-Month Emergency fund for you? While a good emergency fund could even save you from bankruptcy, a whole year of savings might be too much for some people. Find out if you need one!

From a very young age, most of us have heard, and often recurrently, about the wisdom of “saving for a rainy day”. One way of saving for that rainy day is creating what’s called a ‘‘12-month emergency fund’’, which consists of having a backup to cover your expenses for a whole year in case anything happened. 

But is it realistic or even suitable for everyone to have a 12-month income saved up? Is it really how much my emergency fund should have? We’ll be covering this subject to find out if having this kind of emergency fund is right for you and, if it is, what’s the best way to build it. 

Pros and Cons of a 12-Month Emergency Fund

It might be odd to think there are both pros and cons to building an emergency fund, but it’s important that aspiring savers think through all of the implications before they put their plans into action.

✅ Pro – Mitigates Risk During Lifestyle Changes

The arrival of the COVID-19 pandemic was an example of an extreme change that disrupted the regular lives of individuals and families globally. Countless people lost their jobs, and many others became self-employed or changed their lifestyles completely. We’ll deal more with being unemployed later, but for now, let’s focus on lifestyle choices.

Let’s say that you have the ambition to quit your office job and start your own business from home. It’s a huge risk, for sure, but you can do a lot about mitigating that risk if you have a 1-year emergency fund standing by to make up the financial shortfall while you get off the ground. It leaves you with mental space to think about growing the business and not worrying about making mortgage payments, paying bills, and dealing with your everyday expenses if it doesn’t go as planned.

✅ Pro – Reduces Reliance on Credit

Even if no lifestyle changes are planned, a 12-month emergency fund is an invaluable asset for dealing with difficult and expensive urgent situations such as medical bills. And medical issues don’t even have to be as threatening as they sound; something as simple as a dental proceeding might suddenly bring a thousand-dollar bill to the table. Normally you’d have to rely on a credit card to deal with those, but with your emergency fund, you won’t have to.

Not dipping into credit limits means no interest to pay, which means no lingering debts that set you back financially over much longer periods. In your longer-term financial future, you’ll always be glad you were able to pay expenses out of pocket rather than rely on credit cards.

✅ Pro – Lowers Your Personal Stress Levels

Knowing that you have a large pot of money on hand to use in case of an emergency is a great stress reliever. The size of a 12-month fund makes it extra reassuring since you know that it should be enough to cover either a year of regular expenses or any sudden short-term expense that might come your way. It can be a ticket to a more comfortable life moving forward, so the earlier you start building that fund, the sooner you’ll feel the relief.

✅ Pro – Provides Bigger Window to Gain Employment

In the event that you were to lose your job, a one-year emergency fund offers you a large window to search for new opportunities, and you won’t have to settle for whatever comes up first, as you would if you were in a desperate situation.

Even if you had a 3 or 6-month emergency fund, it might not give you so much room to look for suitable positions. How big your emergency fund is will determine how long you can afford to wait for better things.

❌ Con – Ties Up Large Sums of Money

Perhaps the most difficult thing about having a 12-month fund is how much of your income it ties up as you make contributions toward it. If you want to construct a 12-month fund quickly, then you need to put aside a big percentage of your monthly income. Even then, it will still take many months to build it (see next point for more). When you tie up large sums into your savings, it means there’s less disposable income each month, which makes for a less comfortable lifestyle.

❌ Con – Time-Consuming

As introduced in the previous point, creating a 12-month fund while still paying the bills will take you more than a year. How many months it actually takes you to build the emergency fund will depend on the amount you can contribute to it monthly; if you can only afford a small fraction of your income to go toward your savings plan, it will take you quite a long time.

Consider that if you were to put aside half of your income toward building that fund, which is pretty impressive, it would still take you 24 months to actually get it.

❌ Con – Makes it Harder to Deal with Existing Debt

Finally, when you are committing money to an emergency fund and you have existing debt, then you are making it harder for yourself to deal with the debts and interests you have on hand. For some, it can mean that paying off debts takes longer. If you instead focus on canceling your debts before turning to your emergency fund plan, it will take you even longer to build it.

Reasons to Have a 12-Month Emergency Fund

There are a number of situations in which a 12-month emergency fund is a great idea. If any of these apply to you, then building such a fund might be the right path to take.

If you are supporting a family as the sole or primary breadwinner, then a 12-month fund is ideal. Financial security for an individual is easier to get, but family expenses mean things like childcare, education, health and more. These are too important to ignore, and many can’t afford to have corners cut.

Your lifestyle includes many fixed or non-negotiable expenses, such as mortgage payments, medical expenses, education or childcare costs. These can’t be cut down and failing to meet these payments could harm your credit rating or even put you in a bankruptcy situation. A 12-month fund is therefore ideal.

You work in a job you don’t like and have ambitions to move on. Stepping out of a steady job and into a more uncertain (but hopefully much happier) future is a huge risk. A 12-month fund is really the only way to provide adequate mitigation to that risk, and a steady job will help you to fund it more quickly.

To offer a counterpoint, I’ve also prepared some ideas on situations that would make a 12-month emergency fund either unnecessary or not advisable:

You are single and have many ways to cut your own expenses quickly. That would make a 12-month income too much for an emergency fund, when a 3 or 6-month worth of savings is more than enough.

You currently have large amounts of debt and/or interest payments to make monthly.

Right now you are living paycheck to paycheck and don’t have the money to set aside for building a 12-month fund.

You are young and carry ample insurance to protect you against most unforeseen emergencies including medical bills, car repairs, home repairs, and others.

Tips on Saving Enough for a 12-Month Emergency Fund

Is the 12-month emergency fund right for you and your lifestyle? Then we’ll move on to some tips on how to build it efficiently.

Start Early

The more time you give yourself, the less pressure you have to save up a 12-month emergency fund. You can build it in smaller installments, which will take longer but if you’ve started early enough, then it should still be enough time.

Get a Grip on Finances

To get started on an emergency fund, you first need to have a very clear idea of your current financial situation. You’ll need to know exactly how much you have coming in and how much you have to spend. The more detailed is your understanding of your monthly finances, the better.

Channel Existing Savings

One good way to get a head start on your budget is to take any existing savings you have and put them straight into your 12-month fund. Those savings were likely going to serve the same purpose, so they’re still being put to good use.

Don’t Overstretch

Some people, in an effort to build their 12-month fund faster, will overreach in how much they put in their emergency fund each month, forcing them to use credit or miss payments to make up the shortfall. You must ensure you can meet all your primary obligations before you allocate money to the emergency fund.

Be Patient

The fact is that for the majority of people, it will take considerable time to build up 12 months’ worth of savings. Therefore, the best policy remains to start early, be patient, and make small but regular contributions to the fund. A steady and continuous stream is better than going off too fast and then not being able to keep up further down the line. It’s a marathon, not a sprint.