Why is 3 Months the Rule for Emergency Savings?

In the previous blog post, I looked at how many people have emergency savings.  Many financial advisers suggest having three months of expenses saved up.  Why is three months “the rule?”  Why not six months or one month?

The primary occasion for needing emergency savings is when a person loses their job. After losing a job it is possible to get unemployment compensation, which provides some income while looking for new work.   However, while about half of the unemployed get unemployment compensation, the other half either don’t apply or are not eligible to receive payments. This means a large number of the unemployed must rely either on emergency savings or getting help from friends and relatives.

How long is the typical person unemployed? The Bureau of Labor Statistics has tracked data to answer this question since 1948. The average (mean) length of time people are unemployed is almost four months (3.8) and the average (median) is slightly more than two months (2.1). These two values suggest the typical person who becomes unemployed has no job for between two and four months, which leads to the three month rule.

However, just because the average person is unemployed between two and four months doesn’t mean the three month rule is right for you.  Some people are unemployed for longer and others for shorter periods of time than average.  The results are published each month here.

The table for January 2015 shows the older you are, the longer you are typically unemployed.  For example the median 16 to 19 year old is unemployed just 8.5 weeks, while someone 55 to 64 years old is unemployed  16.1 weeks.  This means older people need almost twice the emergency savings as the young.

After age 25 women on average are unemployed longer than men.  This means if you are female you should save more than if you are a male.

Interestingly, Asian men have the longest spells of unemployment.  The median Asian man is unemployed 24.5 weeks, which is over twice as long as the median White man (10.5 weeks).  This means Asian men should stash more money away.

It is impossible to predict the  perfect amount of emergency savings.  However, the government table and the companion table that track unemployment by occupation and industry help people get a better idea of if they should have savings of more than three months, or maybe even less.

In the end the perfect amount of emergency savings is the amount that lets you sleep soundly at night, knowing you are protected in case you unexpectedly lose your job.