Keeping emergency cash on hand is good — but maximizing return is still important.
So, how much should you have in an emergency fund?
When it comes to emergency savings, there are varying opinions about how much cash you should have or where it should be kept. A traditional savings account, a checking account, a money market account or other low-risk investments that are easy to liquidate? And what is too much cash? What is too little? Can’t someone just provide the “Goldilocks” amount?
Actually, there is a “just right” number — but it is highly individualized and subject to change, which explains a lot of the confusion. Where you keep your cash, however, is more clear-cut.
How much should you save in your emergency fund?
Saving enough cash to cover three to six months of expenses based on your average monthly spending isa good goal. Narrowing that general statement requires getting personal.1
First, calculate your monthly earnings and your average monthly spending. This number can exclude non-essential spending, such as dining out, travel or shopping. Just concentrate on your unavoidable costs, such as housing, utilities, healthcare, transportation, food, debt or credit card payments or other expenses.
Then, add up your current savings.Do you have enough in savings in case you lose your job or have a minor emergency? Consider how much you're setting aside monthly, as well as how soon you’d like to achieve your savings goal.
Once you determine how much you need for one month, consider how many months you’d like to save for. Picking your multiplier depends on your personal circ*mstances. Is your job secure? Do you have a family depending on your income? Do you have other sources of income? Are there ongoing health concerns?
If you are healthy, have a working spouse and no children, three months of savings will likely suffice. If you support children, have one income source and some health costs for example, six months, perhaps more, might be the right number. As your circ*mstances change, your savings goal may need adjustments, as well.
Once you have a well-considered, rational amount for your emergency-fund level, you’ve found your Goldilocks number.
Why is having an emergency fund so important?
Emergency funds are an important part of your financial plan. This money is designed to cover unexpected events like job loss, major medical bills, car repairs, and home repairs.
There is no shortage of financial curveballs that life may throw your way. Having enough money saved in a rainy-day fund will also give you invaluable peace of mind. If an emergency situation should occur, you have quick access to cash.
Where should you keep your emergency fund?
While how much emergency savings you need varies depending on life circ*mstances, where you keep your savings is much more clear-cut. Remember that your emergency cash is a long-term investment — you may never need to use it — with a short-term access requirement.
Because of this immediate access requirement, you need a short-term investment vehicle that pays interest. There are several options, such as certificates of deposit (CDs), your bank’s checkbook-affiliated savings account, a local savings institution, a money market bond fund, or an online cash account.
Choosing an account that is secure (FDIC insured), liquid (no major withdrawal or transfer restrictions) and has no banking fees is a good idea. Make sure you read the fine print — you may be losing more to fees than you are earning in interest.
Our take
Resist the urge to over-save for emergencies. Specifically identifying a rational amount of emergency savings is important because having too much cash also has drawbacks. If you have cash unnecessarily tied up in emergency savings, you may be undermining your long-term goals, such as retirement funding. It’s a balancing act.
How much you have saved in an emergency fund will depend on your unique situation, but ensuring that you have a good safety net in place to cover unexpected expenses is a major pillar of any successful financial plan. A safe, liquid account is generally the best place to park your emergency savings to ensure that your cash is still working for you while remaining easily accessible.
