Why You Probably Have Too Much in Your Emergency Fund

How much should you have in your emergency fund?

Writing that title feels like Personal Finance Creator® blasphemy, but I think it’s time we start examining things from a different angle.

Everyone hears the “3-6 months of expenses in cash” advice – and I was just as happy to play along for awhile (I’ve even written before in the past about why emergency funds become more or less obsolete once you master your cash flow; I’ve since stopped holding a traditional emergency fund and instead just have a couple months’ worth of expenses in checking).

Let’s do a quick rewind:

I can’t say for sure, but I think the idea of an “emergency fund” probably came from Dave Ramsey or a camp like his.

Somewhere along the line, it was minted into personal finance gospel, and we’ve all just been regurgitating the Great Big Book of Dave ever since.

But what is your emergency fund really for?

I found myself really questioning why we just mindlessly repeat “3-6 months’ expenses” when I was talking to a woman in a 1:1. It’s obvious why it’s beneficial to have extra cash on hand; life happens and sometimes you need a little cushion. But where did that specific timeframe come from? Why 3-6 months?

I don’t mean that rhetorically. Really! Let’s discuss some of the circumstances that might cause you to reach for your little cash nest egg.

For me, I always figured losing a job was high on the list. If I lost my job, I’d need to tap my cash reserves to pay rent, buy groceries, etc.

“What if I lose my job?” was always the panic-phrase that my animal brain shouted when I considered the question.

But isn’t losing a job a bit of a worst case scenario? That’s not to say it would never happen – just that there are likely other, more common “emergencies” that would probably be more likely. What other “unexpected” emergencies hit your radar?

Car trouble always seems to top the hypothetical list – new tires, unpredictable expensive maintenance, or something else automobile-related, or maybe a big vet bill for a sick pet. These are things that are likely to happen, at least once per year, as opposed to a catastrophic event like sudden unemployment that you might never experience, if you’re lucky.

(That said, if you don’t own a car, have a pet, or rely on a single source of income… maybe emergencies truly will be few and far between for you.)

Cash emergency funds

Remember, we’re not talking about just having the money in general – we’re talking about having it in cash savings that can be easily accessed

Sometimes I think fleshing out and exploring “worst case scenarios” can help dispel some of the anxiety around them. I remember finally facing the music in April 2020 when layoffs were potentially imminent – I asked myself, “All right, Katie, you’re stressed about the potential of losing your job. What would you actually do if that happened? What does the worst case scenario actually look like?”

If I lost my job, I’d probably try to go on unemployment while I looked for a new job. Unemployment benefits (during the coronavirus pandemic) were roughly $500 per week, + $600 extra as part of the CARES Act. That’s about $1,100 per week (or $4,400 per month) during a pandemic, or $2,000 per month during non-pandemic times.

(These numbers are approximate averages; your state’s unemployment benefits may vary. It also assumes I could’ve actually gotten unemployment, and as we know, it’s not a guarantee – just a decent chance.)

I don’t know about you, but I spend $3,000 in a fat month – as in, I’m balling out. If I’m not balling out and trying to live on a budget (like I would be if I lost my job), it’d be closer to $2,200. Think about it: My entertainment, dining out, personal care, and travel budgets would get nixed (in fact, I did nix them back in April when I was afraid of getting laid off – I went into austerity mode big time as a preemptive strike).

That means regular, non-pandemic unemployment ($2,000 per month) would cover 91% of my monthly expenses, leaving me and my emergency fund to cover the other 9%, or $200 per month.

The other obvious escape chute I’d likely explore if things got really bad is falling back on family or friends. Whether that means parents, grandparents, aunts and uncles, favorite cousins, etc., I’d probably see if I could rely for a short while on a close family member for support. I remember calling my dad one particularly scary day and asking, “If I get laid off, can I come live in your basement?” Luckily, he said yes.

While (a) not everyone has access to that option and (b) it wouldn’t be my first choice, it’s not like I’d be on the street if it all went to shit. It’s likely you wouldn’t be, either, if you have a support system of any kind who could help.

It’s worth noting at this point that this might feel like stupid personal finance advice (“You can always move back in with your parents or a friend!”), but I think it’s a nice realization to tuck in your back pocket to assuage some of the panicked anxiety we feel about “worst case scenarios.” Relying on your community in times of hardship can help you realize you’re not alone.

It begs the question: What’s really an emergency?

The more I thought about it – and the more I talked to other women who were afraid to abandon their giant cash cushions in order to start investing – the more I realized I literally couldn’t conceive of a scenario wherein someone would need immediate access to $20,000 cash all at once with no warning.

You may need to be pulling $2,000 to $3,000 per month (assuming, for some reason, you couldn’t get unemployment benefits or rely on a friend or family member for a place to stay) if you lost your job, or maybe a few thousand for something like an unexpected vet bill if you have pets, but what really constituted an emergency – in my mind – was a bit difficult to conceive of without scraping the bottom of my imagination barrel.

Because here’s the thing: You may end up needing $20,000 over the course of a long-term emergency situation. A bad economic crash with no job outlook and an expensive mortgage, for example (see caveat below), but you won’t need it all at once. That’s a key piece to remember for later.

Caveat: Emergency funds look different if you have kids or own a home

If you own a home or have children, all bets are off.

You’re calculating a potential emergency on a whole different scale, because you have dependents that count on you and, hell, you might need a new roof before the end of the year. Owning a home and having children open you up to endless expensive possibilities, but even then, I think you can still fairly confidently calculate an emergency fund amount that’ll make you feel secure.

Which brings me to my real point…

When you trace back the origins of the emergency fund, it all comes down to having enough cash on hand to not get yourself into debt

Whenever people ask why they should establish an emergency fund before they throw all their money at, say, credit card debt, the canned answer is:

Because if you don’t have an emergency fund, you’re more likely to just get yourself right back into high-interest debt the moment you face an expense that you can’t pay off.

That canned answer isn’t wrong.

If I have $2,000 in credit card debt that I’m slowly chipping away at and nothing in savings, if I get a flat tire and have to replace it for $400, where do you think that $400 charge is going? Right onto the credit card, baby!

The idea is that it’s too easy to dig yourself into the debt hole when you don’t have cash on hand.

But if the point of the emergency fund is to avoid debt, then that means your emergency fund is done when it’s big enough to help you avoid debt

Sounds overly simplistic, right?

But hear me out – if you also can’t conceive of a circumstance wherein you’d need $20,000 at a moment’s notice, you probably don’t need $20,000 in cash.

You’re probably going to be fine with, say, capping your emergency fund at 2-3 months of expenses ($6,000 to $9,000 in cash) and then shifting your focus to growing your wealth actively through investing.

Because remember how I said you wouldn’t need it all at once?

Theoretically, I envision it working like this: Say you’ve got 3 months of cash on hand. Then, you’ve got another 3-6 months’ worth invested in the market.

If I lost my job, I’d start to consider how to begin slowly withdrawing some of the cash that’s invested. If the market was tanking, I’d probably wait and hope for a rebound, and if it was still above the price with which I bought in, I’d probably cash out another month’s worth of expenses to add an additional buffer to my cash cushion.

This way, I’m not sacrificing months (or potentially years) of growth for an unnecessarily high sense of security, but I also still have access to my own money if I need it.

For example, in the “$20,000 emergency fund” example, I’d probably put $10,000 into a savings account for easy access and the other $10,000 into a taxable brokerage account I could touch if I needed it. The likelihood (objectively speaking) that I’d need the invested $10,000 is low, but at least it’s there (and growing) if I need it.

Most people overestimate – not underestimate – how much they actually need in cash savings, and it prevents them from investing

I have this theory that most people don’t actually know how much they spend, and as a result, when they hear “6 months of expenses,” what they really hear is, “6 months of income.”

While using income instead of expenses is a fine barometer, do you know how long it takes to save 6 months of your own income?

Well, if your save rate is 50% (i.e., you’re saving half of your income), it’ll take a year.

If your save rate is 25%, it’ll take two years.

According to Statista, the average American’s saving rate went up to 13% in February 2021 (pre-pandemic, it was between 6-8%).

At a 13% savings rate, you’d save six months’ worth of your income in about four years.

You can see where I’m going with this – it takes a long time.

The reality is, people struggle for years to hit that magical 6-month benchmark, believing that they shouldn’t be investing until they’ve done so. A lot of times, things come up (or, more likely, they decide to use the money for other stuff), and they never hit the magic number that marks the transition from saving to investing.

Call me reckless, but I don’t think it’s necessary

I’d never advocate for ignoring having a cash cushion, but your cash cushion doesn’t need to be a Restoration Hardware sectional. It can be a beanbag chair. Depending on your lifestyle, that beanbag chair might be big or small. The point is, it only needs to be big enough to prevent you from going into debt for realistic emergencies.

Beyond that, I’d argue it’s not necessary.

Because remember: The money you put into your Roth IRA? It’s still your money. You can access the money you contribute tax-free and without penalty because you’ve already paid the taxes on it at any time.

Your Roth IRA is like a back-up emergency fund, except it actually grows. Your taxable brokerage account? Also your money, and also available to you whenever you want.

Investing may be a long-term play, but don’t let “long-term” keep you from starting

Ideally, you aren’t withdrawing that money in the next year. Ideally, you’re in it for the long haul.

But if for some reason you needed that money, it’s still yours and you still have access to it – it’s not like it’s locked up forever.

Sure, in a worst case scenario you may need to withdraw some of your money at a loss, but that’s exceedingly rare – the stock market spends more than half its time “up,” so theoretically, you’re more likely to make money than lose it if you’re investing wisely.

Don’t lose the forest through the trees: The emergency fund is a debt prevention device, but it’s like a medical triage

If you crack your head open, you probably want someone to immediately stop the bleeding and triage the accident – but you can’t stop there.

You have to then go see a doctor and get sophisticated medical care that’s more nuanced in order to actually heal and get healthy. The emergency fund is like a big triage.

Investing is going to the doctor. If you focus too much on the triage, you’ll never actually get anywhere. It’s necessary, but not enough.

It’s an easily deployed cash cushion that helps you prevent credit card debt or other, “Oh, shit,” situations.

Investing is how you build wealth for the future and pave your way to freedom. At the risk of deploying an eye-rollingly cliché analogy that reminds me only vaguely of church camp: Don’t cling to your life preserver so desperately that you miss your golden sailboat to freedom.

Not sure where you should put your emergency fund?

I wrote a post a while back about the account I recommend for hosting a large sum of money, but – surprise, surprise – it’s still an investment account. Your risk tolerance matters here – but check it out.