You should have an emergency fund of at least 3-6 months of household expenses.
First, let’s define what an emergency fund is not – it’s not a bundle of cash in a safe, under your mattress, or in a cookie jar above the fridge. An emergency fund is readily accessible money set aside to cover emergency expenses outside normal expenses. They usually sit in a savings or money market account.
How much should you have? This is part math, part subjective, each person is radically different. Sadly, the amount people actually have is very bi-polar in nature. Either none at all or way too much.
Too little, we know you might have to cash out the wrong investments, wreck tax benefits, push into higher tax brackets, or sell hard assets to cover emergency needs. Is having too much in emergency savings bad? Absolutely. I constantly run into people who have many years of expenses sitting in cash because time flies, business goes on, and taking the time to set up an investment plan for after-tax money simply doesn’t become a priority until the balance is too high.
That’s one area I think this rule often falls incredibly short. There is absolutely a level of cash that is far too much. You give up the opportunity for growth. Compound growth in investments over time makes a huge difference in overall financial health. Sitting in cash is the second worst alternative to spending it all.
Here are a couple items to consider:
- Stability of income/career – stability means less need for actual cash. Investing excess can provide further protection. Instability of income can increase this to over a year of savings. High stability can bring this under a month. And just because you own the business, doesn’t mean the business doesn’t have risk of failure – that can be further instability.
- After tax assets – saving is absolutely good. How you save is crucial. Emergency savings becomes a set number over which you can invest your excess savings in a taxable investment account. The more you have, as long as invested in accessible accounts, can greatly reduce the need for emergency savings.
There are many more aspects we can go into – such as age, risk tolerance, income level, location, potential emergencies etc. I suppose you get the point.
Your emergency savings is a crucial piece of your financial plan and it shouldn’t just be paid lip service. There is a balance. Holding too much is bad. Holding too little is worse. We’re happy to discuss with you the best route for your family or business. Just give us a call at 913.681.9155.