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Last week, I came across a post by Greg McFarlane over at Investopedia called, Why Emergency Funds Are a Bad Idea. And before I weigh in on the crux of his argument, I thought I’d review my emergency fund experience.
My Emergency Fund Experience
First off, Mrs. Groovy and I got very lucky when it came to building our emergency fund. In 2006, we sold our New York condo at the height of the real estate boom and made enough money to buy a house outright and establish a two-year emergency fund when we relocated to North Carolina. So for 11 years now, we’ve had basically $60K sitting in a Bank of America savings account earning squat.
And how many emergencies have we had during these past 11 years? Five. Here they are.
1. When we first moved down to North Carolina, we decided to dabble in real estate and bought a rental property. In 2010, the HVAC system in our rental finally crashed—in the middle of a blistering summer, no less—and we needed to replace it. That costed us $3,800.
2. In 2012, the power steering rack on the Camry went. That cost us $1,200.
3. In February of 2016, Grandma Groovy died and we needed to fly to Boston on short notice: $1,100.
4. In July of 2016, lightning took out our garage door opener: $350.
5. And, finally, in September of 2016, Cousin Groovy died and we needed to chip in for his cremation: $500.
There may have been other emergencies that I missed. But if I did, they didn’t cost much money. Let’s now see why Mr. McFarlane is so against the vaunted emergency fund.
McFarlane’s Case Against the Emergency Fund
First, to make his case against the emergency fund, McFarlane takes the US per capita income of $55,836 in 2015 and assumes an effective tax rate of 20%. This would give the per capita American a disposable income of $44,669.
Next, McFarlane deducts a personal savings rate of 5.3% from the $44,669 to determine the per capita American’s annual living expenses. This number comes to $42,301.
With monthly living expenses of roughly $3,525, then, the per capita American would need the following amounts for the emergency fund sizes recommended by personal finance gurus.
Recommended Emergency Fund Based on Monthly Living Expenses of $3,525
| Size | Amount |
|---|---|
| Three Months | $10,575 |
| Six Months | $21,150 |
| Nine Months | $31,725 |
| Twelve Months | $42,300 |
Okay, with all these preliminary figures in mind, McFarlane goes in for the kill.
If [these emergency fund] numbers sound high, or even if they don’t, understand that in the U.S. the average household credit card debt was $16,048 in March, 2016. Americans are also carrying a cumulative $1.32 trillion in student loan debt, which dwarfs the credit-card debt on a per-borrower basis.
Then he delivers the coup de grâce.
In other words, the math doesn’t come close to working out on emergency funds. If the experts are going to issue a blanket recommendation to millions of people that they should all create a buffer to tie them over in unforeseen circumstances, it would make far more sense to say, “Instead of amassing an account that pays you 0%, or a few basis points above that, maybe you should focus on closing out an account or two that’s costing you 15%.”
And, finally, he offers his prescription.
Take the money you’d otherwise devote to an emergency fund, put it in something even as humble as a short-term certificate of deposit (CD) – that should give you FDIC protection. You can also pick a higher-risk blue chip stock or bond fund – which adds to your risk, but gives you instant access to your funds if you need them. Either way, you’d be building wealth instead of watching it methodically diminish. Taking the time to build an emergency fund, and forgoing consumption for months while doing so, is a staggeringly inefficient use of the precious and limited resource that is your money.
Is McFarlane Right?
Providing your insurances are all lined up, as McFarlane also stresses, I think he has a valid point. It’s probably better to pay off all of your consumer debt before you start an emergency fund, and it’s probably better to put whatever emergency fund you do establish into a bond fund so it can earn a two percent return.
But then again, my emergency fund experience may be atypical. Mrs. Groovy and I haven’t been hit by any killer expenses out of the blue. My father, on the other hand, had to spend $16K a few years ago for a four-month supply of a blood-clot medicine that wasn’t covered by Medicare. What if either Mrs. Groovy or I had a similar setback? What if one or both of us had lost a job? And what if we had kids and all the unexpected costs they thrust upon a family? Would we have viewed our emergency fund under those circumstances as a “staggeringly inefficient use of [our] precious and limited resource[s]”?
Damn! No one ever said blogging about personal finance was going to be easy. In light of Mr. McFarlane’s convincing anti-emergency fund arguments, I have modified my stance on emergency funds. Here are my new guidelines.
- While you’re paying off your consumer debt, keep $1,000 in a savings account as an emergency fund (King Dave is right on this point).
- Once you’ve paid off all of your consumer debt, keep no more than $5,000 in a savings account as an emergency fund. Five thousand dollars should cover 90 percent of the emergencies you come across.
- Do what McFarlane suggests. Put whatever additional emergency fund money you need for a good night’s sleep into a CD or a bond fund. A two or three percent return is better than nothing.
Final Thoughts
Okay, groovy freedomists, that’s all I got. What are your experiences with an emergency fund? How many months of expenses do you have sitting in a savings account losing value? And how many times have you actually used your emergency fund over the past five or ten years? Do you find the standard advice on emergency funds to be overkill? I’d love to hear what you have to say. Peace.
2020, bet everyone wishes they kept a large emergency fund now.
Damn straight! Thanks for reminding me that I’m not as brilliant as I sometimes suppose. I think it’s time to add the following warning to all my posts:
WARNING: The author of this blog has a penchant for talking out of his ass. Therefore, be skeptical of everything he writes.
Interesting debate.
Not knowing it, we took the McFarlane approach. Paid off all debt first before saving an emergency fund. We have a $50K NO – A – TOUCHY fund now. Which is in case our Internet biz collapses due to a change in Google’s algorithm.
It would give us a full year to grow another stream, and FREAK out! 😳
Before our debt was 100% paid we just had the HELOC to fall back on.
Great to be back here in Groovy land.
I love it, Brent. A %50K No-A-Touchy fund is pretty impressive. And very likely needed as a hedge against Google’s fickle search algorithm. Funny, I almost had to write a post that back-tracked on my $5K overkill claim. Our neighbor just learned that water damaged has destroyed the structural integrity of his two-story front porch. The first contractor quoted him $7.5K for the repairs. We got an inspector to check out our two-story front porch because it had signs of water damage too. Fortunately for us, the water damage was just superficial. Some trim work has to be replaced, but the underlying beams are fine. Trim work should cost around $500-$700. Whew.
When I opened the pool this year I ruined the liner. Total bill for liner and coping was estimated at $9700.
We were ready for it but it still stung. My Mom told me to check with our insurance company and amazingly they insured it.
Shocker cause it was an old liner.
Hubby & I were thinking about this. We thought we needed 25K because we have a rental as a liability so it doubles our mortgage. But we’re thinking of lowering it to $5000 (max) and keeping another $15,000 in either CDs or municipal bonds.
It’s really annoying prepping for an emergency because they vary so much in size (duh) and I like to play it safe but I’m also a greedy brat for my returns 😛
“…I like ti play it safe but I’m also a greedy brat for my returns.”
Haha. Best comment of the week. I have a monster emergency fund, but I haven’t come close to using it since it was established 11 years ago. I think your $5K cash and $15 CDs/municipal bonds is a reasonable compromise. If you didn’t have the rental, you could safely drop your total emergency fund to $10K. But the rental does expose you to more risk and you should account for that risk. Love the way your mind works, Lily. Thanks so much for stopping by.
Great post! I think I am in agreement with you.
Currently we have $4500 in a savings account (I want to get this amount up to $5,000) for emergencies. I was thinking of bumping it up to $10K but after reading this I bet $5K is plenty.
I then was keeping everything else in a Betterment account which just recently cracked $16K. I realized this money would be better served aggressively paying down DH’s student loan debt.
Once that is gone I think I’ll just put my additional “emergency” fund savings (the stuff above and beyond the $5K) back into the market.
I love it, Cynthia. It never hurts to experiment a little. If the $5K cash emergency fund proves to be a bit too stingy, you can always bump it up. I’ve been very fortunate. My emergencies have been small, and they haven’t attacked me in bunches. So for me, a $5K cash emergency fund coupled with $15-20K backup emergency fund made up of intermediate bonds seems very adequate. Thanks for stopping by, Cynthia. And keep me posted on how your emergency fund experience unfolds. Cheers.
I always love reading people’s views on this topic. It might be an inefficient use of money, but it offers me peace of mind which is more important than math.
I have $20k sitting in a savings account earning 3% per annum and while investing might grow the money quicker, the market might also be down right when I need the money so I’m comfortable with the opportunity loss here.
Totally agree with you. Three percent is a great return for a safe investment. No need to risk any portion of your emergency fund in the market right now. Like you said, the market is a fickle beast and it might just tank when you need it. Thanks for stopping by, Miss B. I really appreciate what you had to say.
Do you mind sharing how you are able to secure a 3% return?
Thanks
I feel like emergency funds are as much psychological as they are actual financial protection. With extremely low interest on savings and CDs these days, it’s a valid argument that our stashed away emergency fund is actually losing money against inflation.
But if the alternative is having no cash on hand at all, people may fall into the paycheck to paycheck trap. And if/when large unexpected expenses occur, are forced to use credit cards.
If we can educate people on investing in taxable accounts, that may be the best alternative. Accessible money within a week, but still growing above inflation.
Thanks for the article. Some great perspective!
“I feel like emergency funds are as much psychological as they are actual financial protection.”
This one sentence nailed it. A large cash-based emergency fund not only allows you to sleep at night but also allows you to do such things as start a business or stand up for yourself at work. Freedom from worry is a wonderful thing. Thanks for stopping by, Matt. You expressed the power of an emergency fund much better than I did.
I am sitting on 2 years of an emergency fund but I justify it with the 4% interest rate my credit union gives. If that wasn’t the case I would invest it. Then again, some days I think I should just throw it in VTSAX and let it ride but I am not willing to pull the trigger just yet. I go back and forth between that and buying an investment property…decisions, decisions. 😉 Hopefully in time the market will tell me what to do.
Hey, how do I become a member of your credit union? 4% is freakin’ great! No, I would hold off on throwing more into VTSAX right now. The market seems high and the political landscape is very weird. Wait till we get a nasty correction and then clean up with your emergency fund. We’re still considering different strategies for our emergency fund, but I think we’ll wind up staying put. We’re just a little too nervous right now to reduce our cash holdings. Like you said, Miss M., decisions, decisions. Why is personal finance so damn hard!
I think that the point he is missing is that when emergency funds are recommended to cover things like job loss, generally it is not recommended to have enough in there to cover every single bit of your wage – rather the bills that you would HAVE to pay in an emergency situation.
I personally think, have it as high as is comfortable for you. Some people will be lucky enough to not have an expensive emergency pop up, but some will have many. We just don’t know 🙂
So true, Francesca. The great unknown is the fly in the ointment. Mrs. G and I have been very fortunate. The handful of emergencies that came are way were relatively cheap. But what if one of us got a serious illness or lost a job? I could never blame someone for erring on the side of caution–especially if doing so isn’t sabotaging his or her other financial goals. Thanks for stopping by. It’s always great hearing from our political and cultural cousins from the other side of the pond.
I don’t like large emergency funds while you’re still in the wealth accumulation phase. In retirement, I plan on keeping a year or two of expenses in cash, but right now I’d be comfortable with $4-5k. Mrs. Vigilante is a little more risk averse than I am, so we’re building up our Emergency Fund to about double that this year. But I don’t see how it will be necessary: We have no debt other than my low interest student loans and our mortgage, we have incredible job stability and flexibility, we have low enough expenses that we could make ends meet by flipping burgers, and we have tens of thousands in available credit if the emergency is large and urgent enough (and the credit card debt could be paid off quickly just by stopping our retirement contributions for one or two months). So why hold all that money in cash, with all the drag of 1% interest, max?
Hey, IV. You guys are in a great position. And I agree, it’s highly unlikely you’ll see an emergency that is more costly than $10K. The largest emergency that Mrs. Groovy and I have faced since 2006 is $3,800. But stuff does happen and you don’t want Mrs. V worrying about this matter. Happy wife, happy life. Thanks for stopping by, my friend.
I have almost 7 months of expenses in my emergency fund that I have through Capital One 360 plus I also have a savings account that has a decent stash in it as well. I’m saving up for a new(er) car so I don’t need to take a loan out when the time comes. This savings account has come in handy when I had some high medical bills a little over a year ago. I also used it to help pay off the credit card when I paid for a vacation. 🙂
It helps me sleep great at night!
“Sleeping great at night” is the real key. And everyone has a different “sleep great” amount. Rationally, I know my that a good chunk of my emergency should be moved out of cash. But I’ve grown accustomed to it and it definitely allows me to sleep well. Also, I’m reading Tony Robbins’s new book Unshakeable and he says the investment giants all believe in being strong on defense. And what better way to play defense than to have a very comfortable amount of cash? Yes, your cash is slowly being eaten away by inflation. But when the next 2008-like crash comes, you’ll have plenty of money to jump on some very cheap stocks. Thanks for stopping by, Linda. It’s always great hearing from another person who has no trouble sleeping at night.
I just have cash accounts and investment accounts. It’s honestly all available in an emergency. 😀
I want to say I have roughly $25k in cash….how long that will last depends entirely on how much I spend. And of course, there is also some bond investments which I would be okay selling if needed.
In regards to drugs that aren’t covered by Medicare, make sure you Groovies get your free prescription discount cards from both LowestMed and GoodRx, so that you can shop prices.
Hey, TJ! Slow down a little bit. Mrs. G and I are still 8 years away from Medicare. But thanks for the advice, my friend. And great job on your emergency account. It’s nice to know that if an emergency arises in your journey across America, the money’s there.
My problem with emergency funds is that an emergency trip to the hospital that requires 2-5 days stay, or an emergency trip to the dental office could eradicate your $5,000 emergency fund.
Yes on one hand I agree $5,000 is overkill, so I’d say put anything beyond $5,000 into investments and then sell them off if you have a big emergency fund.
Like say your EF is $20,000 but you keep $5,000 in a money market account and the rest in investments. If you do have that one big emergency you can sell some of your investments.
$5K cash and $15K in stock or bond indexes–sounds like an awesome strategy to me. Nailed it, Lila.
I’m guilty. I usually have a high amount sitting in a low interest savings account, but not nearly $60k! I bit the bullet a couple of months ago and used a large chunk to pay off a rental property totaling 4 properties paid in full. I was able to part with my savings because I also know that I have a large line of credit on my business credit cards and I receive the low interest convenience checks every month. However, I still do like a hefty amount in the account, because as real estate investors, if something goes wrong, or there is a vacancy, it is in the form of writing a check, instead of just seeing a percentage drop from an online account. We are also planning a RTW trip in 2018, so I want easy access to a lot of cash, if necessary.
Totally agree with you. Much can go wrong in real estate, so it’s best to have a solid emergency fund, whether that fund is composed of cash, investments, or credit. After all, tenants lose jobs, it’s not easy to evict bums, and units could go vacant for months. Thanks for stopping by, PP. And keep us posted on your RTW trip in 2018. I’m so freakin’ jealous.
“Along with changing your oil every 3,000 miles and checking your child’s trick-or-treat bag for weaponized apples, the common advice to create an emergency fund is overly prudent.”
I laughed out loud. Greg is funny.
We have a laughable emergency fund right now, but we’re working toward a year’s worth of expenses. This whole e-fund thing is evolving for us since we’re saving for a new goal. Will have to keep thinking about this…
Agreed. Greg is a riot. And his rye sense of humor is one of the reasons he’s regular on Stacking Benjamins.
Keep us posted on your emergency fund. Mrs. Groovy and I are re-thinking our strategy and we’re curious to know what you guys think.
Hope all is well, Claudia. Talk to you soon.
I’ll probably get yelled at but I’m totally adverse to keeping emergency funds in cash. I’ve always invested our emergency fund. Walking away from 8% returns on 60K (or however much you feel is right) just seems wrong.
I try to make my case in http://millionin10.com/investing-your-emergency-fund/ but to make a long story short, when a medical emergency of $12,700 came around I sold shares from the fund. Shares I paid $9000 for to begin with.
Haha! There will be no yelling from me. The Scott Allen Turner approach to an emergency is quite valid. Letting 60K fester and not earn 8% is hard to stomach. Thanks for the link, my friend. Mrs. Groovy and I have a lot of thinking to do this weekend, and I’m sure your article will prove very useful.
Just found the blog – I’ve worked in the financial industry for 15 years and also travel hack for our vacations (like our trip I just booked to Papagayo, Costa Rica in Sept that will cost us a grand total of $165 for the taxes on the flights and a luxury hotel). I have $20k in our emergency savings which is roughly 6 months of necessary expenses for us. I have that in a credit union savings account to build a relationship with them, as they have the most attractive mortgage product that we’re considering when buying property in the next year or two (earns very little though). I was laid off last summer, so having that cushion was incredibly helpful to put my stress level lower which allowed me to focus on getting the right job, not just any job. I ended up with a 35% pay raise plus 5 figure bonuses as a result and was able to take a month to travel before I started the new job. Psychologically, having the hefty emergency savings meant a lot.
Now, from debt incurred from a prior marriage and the only time in my life I’ve owned property, I spent about 5-7 years of my 30’s working to pay off debt, to the point where I got everything but student loans paid off the month after my 2nd wife and I married. We went frugal (<$2k) on the wedding and have no regrets. Right now, we both only have student loan debt (roughly $60k between us at < 4% rates) and one "car" loan (1.99% unsecured – $23k bal) we own the other car but the paint job is awful looking and would cost more to paint it than it's worth, and the wife is frustrated about that.
My struggle is that while we have a nice emergency savings, we are also working on building at least a 5% down payment for a house as well as about $7,500 as a "rainy day fund". The issue is that we are both WAY behind in retirement savings. I'm 41 and I have about $60k between 401k and a ROTH IRA. I contribute 10% to 401k now and the annual max to the ROTH. The rainy day fund amount is a drop in the bucket. I plan on using my future annual bonuses as 100% 401k contributions if possible once we hit our house down payment and rainy day goals.
If I have any "savings" panic, it's retirement savings. According to other media I've read, I should have around $240k in retirement savings at this point. How can I close that gap sooner than later?
Hey, Scott. First off, can Mrs. Groovy and I go to Costa Rica with you? That $165 for the flight and the hotel is incredible. Second, I love what you’re doing with savings and retirement. Yes, you’re a little behind, but you’re still young. Mrs. Groovy and I didn’t start saving for retirement until we were 45. And, yet, by the time we were 55, we had enough to retire. One of the keys for us was housing. We had a paid off house by the time we were 45. Not having a mortgage allows you to throw a lot of money at retirement. My advice for you is twofold. One, up the 401(k) contributions to 15-20%. Two, seriously consider a modest home. Our friends Claudia and Garrett over at Two Cup House downsized from a 1,600 sq ft home to a 536 sq ft home. It wasn’t easy, but they paid off the mortgage to the smaller home in a year. They’re now in their early 30s and completely debt free. So if you have the stomach for a radically small home, you have a good shot of retiring in your early 50s.
Best of luck, Scott. I really appreciate you stopping by and sharing your story. Cheers.
Nice post! We’ve had $12,000 (about 3-4 months of expenses) as our dedicated emergency fund in an online savings account making ~1% for a couple years. We have a larger amount in the same account left over from saving up for a house that I wanted to put towards a remodel in a year or two but I am shifting away from that and saying 5 years at least. We are looking to get that into a more moderate account earning 5-6 percent but still want easy access. I do think that the emergency fund is going to be different for everyone since they all have their own risk tolerances and circumstances. For me, as an Architect, the industry is very boom or bust and we were hit really hard in 2009 and I lost my job. Now that I am married with 1 kid and another on the way I need more insurance in case that happens again. For that reason, $5,000 would not be enough and I would want closer to 6 months at least. Also, if you own or rent should factor into it as AC units and new roofs always seem to cost $10K.
“I do think that the emergency fund is going to be different for everyone since they all have their own risk tolerances and circumstances.”
So true, Kevin. My cousin is an architect as well, and he had some very lean years after the 2008 crash. But thankfully he is good with money so he always had the money to pay his office rent. So if you have a job that is subjected to a boom/bust cycle, a roof that is twenty-five years old, and a bunch of moppets running around, it’s better to err on the side of caution. At the very least, have a six-month emergency fund. A twelve-month emergency fund would be better.
Thanks for stopping by, Kevin. You provided some very wise commentary.
Well, due to the uncertainty in our industry we ramped up our cash stash to a years worth of funds. After Mrs. SSC quit and went to teach I figured we’d invest most of it but it’s now our “sleep at night” number. If things crash and I get let go then we can cover things for at least a year, maybe longer. Works for me.
Since we’re getting within a yr or two of quitting or at least losing my main income that will probably ramp up closer to covering 2-3 yrs like you guys. So what if we lose opportunity for growth, that’s not what we’re gambling it with. We’re gambling on it being there when the growth stuff loses 40% or so.
Like Michael said, it’s like auto insurance, it sucks until you get rear ended and need it. Then you’re glad you had it regardless of sunk costs….
Haha! You and Michael nailed it. Insurance does suck until you need it. Imagine if you retired at the end of 2007 and entered 2008 with a two or three year cash emergency fund. The odds are you would have stayed retired and rode out the downturn. But what if you had a three month emergency fund? Would you have been able to stay retired? The first five years of retirement are critical. Best go into retirement with a very healthy emergency fund that can’t be hurt by a market crash. Thanks for stopping by, Mr. SSC. I love the cut of your jib.
Let me put it this way. Everyone carries auto insurance. It is a PITA. No one realizes the value of it until one is in an accident.
Similarly, an emergency fund is a form of insurance. In the current interest rate environment, it is an eye sore to watch it collect ~1% returns. If the interest rate was around 4%, then we wouldn’t be having this conversation.
I agree with your rationale. If anyone is drowning in consumer debt, it is better to have $1000 as an emergency fund, and work towards paying off consumer debt.
If you are consumer debt free, then if both husband and wife are working, one should have at least 3 months of reserve – to cover for unexpected job loss or medical disability etc.
Aaarrrggghhh! This is so frustrating. Everyone here is making excellent arguments. My rational brain understands that the non-cash emergency fund makes a lot of sense for a lot people. But my lizard brain sees the benefits of a well-stocked cash-based emergency fund. There’s something special about knowing that practically no emergency can hurt you. It really makes sleeping at night quite easy. So, yeah, I love your suggestion. No consumer debt + husband and wife are working = 3 month emergency fund. Thank you for stopping by, Michael. Another great contribution to our conversation.
I”m not a fan of the traditional emergency fund, but I do think they are good for certain situations. Personally I’ve got about $10K in cash right now, which is too much for me. I’d like to get that down to $1000.
My ’emergency fund’ is my access to credit. I’d prefer to let my cash work for me via investments. If an emergency comes up I’ll cover it with my AMEX, then I can sell whatever assets I need to to pay off the CC bill.
The downside here is that should I lose my access to credit (job loss, banks tightening up, fraud), then I’d be left w/ little cash on hand. I could sell stocks to generate the cash, but it could leave me vulnerable for a short time.
Hey, Ty. You have a very sound approach. There’s no reason why credit can’t act as an emergency fund. I think the factors in going this route are threefold. How often do you have an emergency? In the past 11 years, Mrs. Groovy and I have had 5 emergencies, roughly one every two years. How costly is your typical emergency? The largest emergency for us was $3,800. And, finally, what’s your comfort level when it comes to market risk? In a rising interest rate environment, bond funds could have a year or two of negative returns. If you answered “low” for the first two questions and “high” for the third question, a credit-based emergency fund is a good option. Thanks for stopping by, Ty. You gave me a lot to think about.
My husband and I have $10,000 set aside for emergencies. I would feel more comfortable if it were $20,000 but I realize that the difference can do better work invested. I like your modified approach on where to save the difference. I think having some emergency fund money provides peace of mind, which is important.
I’m with you. As you so eloquently expressed, the purpose of an emergency fund is twofold. First, it’s there to pay for emergencies. Second, it’s there to give you peace of mind. If the $10K emergency fund isn’t cutting it, there’s no harm in bumping it up to $20K. Thanks for stopping by, Pamela. I really appreciate it.
Great article, we used to have 20k sitting in a low interest savings account. We are now down to 5k, and I wrote an article about this same topic as well on my blog. Basically, we haven’t had a real emergency over 3k either.
Do you travel hack? That last minute flight could have been free, if you had miles and points accumulated prior to the event. It’s pretty easy to do.
Hey, FinancePatriot. I’m gonna have to check out that article on your blog. My worst year for emergencies was 2010, and the lone emergency of that year cost us less than $4K. So I think a $5K emergency fund will cover 80-90% of all emergencies. But it’s nice having a large emergency fund for those outlier emergencies. Thanks for stopping by, FinancePatriot. I really appreciate it.
I agree with you in principle. If you have outstanding high-interest debt, a small emergency fund ($500-$1,000) could go a long way to protecting you. After that, if you have a stable income and not too much risk of emergencies, $5,000 should be sufficient. But I think each household has to weigh the specifics of their own situation. If you have high minimum expenses, that might not be enough. If you own a number of rental properties, or have a lot of kids, or don’t have a steady income, or have exposure on any number of fronts, it might not be enough. Personally, our e-fund is a bit over $5k, but not by that much.
“But I think each household has to weigh the specifics of their own situation.”
So true. Everyone’s situation is different. We have no debt, no kids, good health, and small monthly expenses. And, yet, we never thought of making due with a $5K emergency fund. We know a two-year emergency fund is overkill, but it completely removes worry from our lives. It’s a cliche, but that kind of peace of mind is indeed priceless.
Thanks for stopping by, Gary. I always love your perspective on things.
This is where I was going to go. The larger the number of people who depend on your income (or the more unstable your income), probably the larger an emergency fund you need to set up before you aggressively tackle your high-interest debt. For most families, $5000 may be too high (if income is stable). For a big family? Maybe not.
Once you’ve paid off the debt, though, it’s good to balance out your investments with a few months of cash.
I’m sitting on almost a year’s worth of cash right now, and all things considered (stock market, health care, etc) I wish it was a bit more. But we just have mortgage debt, and the type of investments we have means more cash will be coming in from interest and dividends.
Agreed. Greg McFarlane and Scott Allen Turner both make excellent cases for having a non-cash emergency fund. Turner even suggests putting your emergency fund in an S&P 500 index fund. But to do this, he suggests you do so with a 100% premium. In other words, if you want an emergency fund of $20K, put $40K in the S&P 500 index fund. This way, your money is getting a reasonable return (for most years) and it’s reasonably safe that you’ll always have $20K handy for an emergency. How often does the S&P 500 drop 50%? But even though I can’t say McFarlane and Turner are wrong, I’m in no rush to drastically reduce my all cash emergency fund. Like you said, Emily, things are kind of jittery right now with the stock market and healthcare. And I’d rather have the cash on hand to weather any storm that comes. So I’m with you. The more things are unstable, the larger the emergency fund should be.
I think if you have the consumer debt, especially with a high interest rate, that should be a priority. At the same time, I think having a small amount for emergencies is useful so you don’t have to add to the debt when/if you do have an emergency.
It’s funny, our emergency fund just took a dive yesterday when I funded our IRAs for the year. Since I’ve always kept a pretty good size cash buffer (about 8 months) and now it’s down to 5 months, I was feeling a little uncomfortable. This post helped. The thing is, we have a HELOC in place and savings for our future rental property, so it’s not like it’s a big deal to keep less in the emergency fund. It’s definitely a mental thing for me. I’m a work in progress. 🙂
Agreed. An emergency fund is indeed mental. Math and experience say our emergency fund is overkill. But our over-sized emergency fund has allowed Mrs. G and me to sleep very comfortably over the past 11 years. What value do you put on that kind of peace of mind? You’re probably good with your current 5-month emergency, but I wouldn’t say an 8-month emergency fund is being overly cautious. And I forgot all about HELOCs. I wasn’t sure those loans were still around. Thanks for stopping by, Amanda. It’s always great hearing from another person who likes bigger-than-necessary emergency funds.
Our emergency fund is getting too big. We need to start ramping up our investments again. Optimally we would only keep a 5k buffer in our checking account. Credit cards can be used to cover our short term needs, and over the course of a few days we can always sell some bond funds for emergency cash. Like you, I don’t like having lazy money sitting around earning 0% 🙂
Excellent point, Mr Crazy Kicks. If you have no credit card debt, you can afford to have a modest emergency fund. Like you said, if an emergency comes up that exhausts your emergency fund, your credit cards can tide you over while you sell some bond funds. No credit card debt = no need to panic. Thanks for stopping by, my friend.
It is lightning not lightening (#4 in your list)
Thank you. I made the correction.
Brace yourself. We have $23k in a e-fund. Plus what we have in savings. It’s too much money most of the time. But when our AC, shed, and roof all went within a few months of each other, $5k wouldn’t have cut it.
Once the baby comes and we get settled, we’re hoping to move that money to an account that can earn something besides 1%.
To go back to the bigger question at hand, it really depends on what you use your e-fund for. I know a lot of people who use their e-fund for major car repairs. We just save for that. Different strokes for different folks.
Stop it. A $23K emergency fund is very reasonable, especially when there’s a baby on the way. The problem is the current interest rate environment. Prior to 2008, it wasn’t hard to get a six-month CD for 4 or 5 percent. But now it really hurts to see tens of thousands of dollars earning less than 1%–and that’s before inflation is factored in. But as you pointed out, Penny, we got to stay disciplined. ACs, sheds, and roofs do decide to fail at the same time. And we all know a 2008-like crash is coming. So while we curse our idle money now, we’ll be thankful as hell when it’s there for the next multi-staged emergency or market crash.
I think the amount of your emergency fund depends on your income and expenses. I wouldn’t be comfortable with just $5,000 of emergency expenses because I like having 2 months’ worth of expenses stashed away. But I don’t think you need anything much bigger than that, since it’s best to put your money to work by investing or paying off debt.
Agreed, Mrs. PP. A two-month emergency fund is a reasonable compromise, especially if your track record of emergencies is rather light.
I’m 100% on board with paying off your high-interest debt before building an emergency fund. I actually recently wrote about why I disagree with Dave Ramsey’s advice to keep $1,000 in an emergency fund during this stage. I’m in favor of just paying it all off ASAP.
I keep a relatively small emergency fund (maybe 3 months). I looked into putting some of it into bond funds or CDs or some other method to earn some extra interest. The actual extra money earned on it would be pretty small, though. I decided that it was fine to pass up on that minimal extra income in exchange for saving the time and effort on the other avenues. On the credit card when you’re talking about 12% or more, then I would definitely maximize my return. When dealing with 2% and only on whatever limited amount you keep in an emergency fund, then maybe not.
“On the credit card when you’re talking about 12% or more, then I would definitely maximize my return. When dealing with 2% and only on whatever limited amount you keep in an emergency fund, then maybe not.”
The last two sentences of your comment say it all. Don’t let that killer, high-interest debt stick around. If you have to forego an emergency fund to wipe out that high-interest debt, do it.
Thanks for stopping by, Matt. I love the way your mind works.
We have about $50k in cash right now. If the stock market was cheap, I might stash some there. But beings we didn’t go back to the 9-5 after our year off and are kind of playing it by ear, I like the cushion. Between that and our passive income we could easily not earn a $1 for the next 7-12 years and still be fine. (That’s NOT the plan!) But it’s nice to know. It gives us a few years to tinker around and figure out what we want to be when we grow up. 😉
Agreed. We have a lot of cash right now as well. And because stocks and bonds look rather costly from my perspective, I’m not particularly bothered by the negative return our cash is getting. When the next 2008-like crash comes around, we’ll not only have the money to pay our expenses, we’ll have the money to jump on all those ultra-cheap stocks. Love what you’re doing Ms. M. Being able to go 7-12 years without needing to earn a buck is pretty damn impressive.
I’ve never been too concerned about having a large emergency fund simply because our household earns 5% interest on our emergency fund (and all in an FDIC insured savings account).
It takes a little work to set up (which is why 99% of people aren’t comfortable taking advantage of these accounts) but once it’s set up, everything is completely automated. Everyone can get 5% interest on up to $15k and if you’re a household, you can get up to $30k earning 5%. In that situation, I don’t think you’d have to feel so bad having a bunch of money sitting in cash.
I’ve personally got $8k sitting in my emergency fund right now, which might be a lot for some people, but it’s all earning a guaranteed 5% And I’m consistently adding more into it each month simply because I’m trying to max out these 5% interest accounts.
Wow! That’s awesome. Mrs. Groovy read your comment on her phone while we were running errands. When she finished, she turned to me and said, “I think we need a Groovy meeting on our emergency fund.” We need to check out that 5% interest card. Thanks for tweeting the link and for stopping by, my friend.
I was just on Financial Panther’s site looking this up. I’d love 5% – even if it takes some work. Great thoughts from everyone here. We are not fans of big emergency funds – but I may reconsider when I retire soon too. We have access to other funds in retirement accounts that we aren’t depending on (and won’t get penalized for taking out) – so we don’t have much sitting in saving accounts.
There is wisdom in weighing out the pros and cons of savings vs. paying off debt. I think it entirely depends on your situation. For you (and many Americans with stable living situations), having a large emergency fund may not make sense. You don’t have a lot of risks. For a lot of younger people like myself, the world is full of risks. For unlucky/previously stupid people (also like myself), the world is also risky. I bought a home with my husband at a time when we had no business doing so, and it ended up costing us over $30,000 in repairs in two years alone after managing it as a rental long-distance because we couldn’t sell it after we relocated for my husband to go to college. This was at a time when I was just making it out into the working world after graduating, and I sort of fell flat on my face in that department too, snagging the highest-paying job I could get at $32k/year. My employment situation is still not stable (I’m currently freelancing right now while waiting for the fed hiring freeze to lift, and who the #$%@ knows what’ll happen after that), and my husband will be graduating soon as well. So, for young people in our shoes, I recommend this approach: save a $1,000 emergency fund. That’ll cover just a few expenses that may crop up. Pay off high-interest credit card debt. Then, throw 2-3 months of living expenses into savings, because it’s usually going to be a long slog to pay off the rest (we’re working on >$100,000 of student, auto, and personal loans), and you need to be prepared while you’re still vulnerable. After you’ve got that, then fire away at the rest of that debt. Pew-pew.
Great point. The size of your emergency fund should be commensurate with your risk exposure. If you have a lot of risk, don’t skimp on the emergency fund. And I love your recommended approach. Sound advice for anyone, especially a Millennial who has a lot of student loan debt. Thanks for stopping by, Lindsay. I really appreciate your perspective. And good luck on the job hunt. Sadly, I think the federal government’s going to be screwed up for a number of years. Sigh.
I prefer your new guidelines, they are similar to what we employ currently. The amount of your emergency fund in total is an interesting question. Alternate income streams, multiple income streams, the liquidity of investments, availability of debt, and your personal risk tolerance all come into play. But even if you require the largest emergency fund imaginable you should be maxing out your risk free return.
“But even if you require the largest emergency fund imaginable you should be maxing out your risk free return.”
I like that, FTF. Moderation is the key. Protect yourself but don’t go crazy.
First, I’m sorry to hear about your loss in Sep 2016. Are you doing okay on that point?
I have 6 months of expenses in my savings account or roughly $10k.
Guess what? I have peace of mind when I go to bed at night – I don’t ever think about not having enough cash in the bank for the next day. So what if I’m not maximizing my returns in the market, if something bad happens, I’m not diving into debt to fix it.
Thanks for sharing FIG.
Thank you, Erik, it’s very kind of you to ask. It was unexpected but we’re doing OK.
You sound like Mr. Groovy in terms of being able to sleep at night. That’s our financial barometer these days.
Mr. Groovy did not mention this but several times over the last 10 years, including now, we’ve been interested in making a land purchase. Having the cash on hand would allow us to move quickly. Also, there was a 2-year period where we had the bulk of our money in a no-penalty CD yielding 4% (those were the days). Still, no reason not to put it into an account yielding 5% as Financial Panther recommends.
Thank you, Erik. I really appreciate your kind words. Yes, having a savings cushion that allows you to sleep at night is very important. This cushion is different for everyone, obviously. And like you, Mrs. Groovy and I prefer to err on the side of caution. Better to have too much than too little.
We have over three years of living expenses sitting in a 1% Ally savings account. This also serves as our emergency fund. This is the money that we’ll be living off of as we begin our new traveling lifestyle. Our goal is to not touch our investments at all until absolutely necessary, and if a recession does hit in the coming months (or years), we *should* be able to ride through without doing a lot of selling.
I think there is wisdom to paying off your high interest debts before focusing on an emergency fund. In fact, I have always been a proponent of getting rid of your debts before focusing your attention on other things. Especially if you have a full-time job that is *reasonably dependable*, high interest debts are KILLING your ability to get ahead.
I might not run a near-zero balance in my checking account, though – I personally like to have at least some money set aside. But a year? Even six months? If you have debts that incur more than 12 or 15% interest every month, I’d personally focus on paying them off first.
Agreed. Mrs. Groovy and I are following the same approach. We have 3-4 years of living expenses in a couple of low-interest accounts. The first five years of retirement are critical and we don’t want to get derailed if another 2008-like crash happens to come along. Thanks for stopping by, Steve. I hope you see some 70-degree days shortly. The 90+ stuff this early in the year is rough.