Everything You Ever Wanted to Know About Emergency Funds

April 26, 2007

An emergency fund is a personal thing; each person approaches the topic in a way that best suits their situation. Several personal finance bloggers teamed up to answer the following reader question, each with their own point of view:

Is there such thing as saving too much money in an emergency fund? What’s the best place to keep the money you do save so it still earns you something while just sitting there?

The three posts listed below contain answers to this question from Lazy Man & Money, Binary Dollar, Money Matter, & More, The Digerati Life, and Suns Financial Diary. Following the article links I’ve summarized some key points made by the writers and from reader comments:

Money Question – Can You Save Too Much in an Emergency Fund?
Can You Be Too Conservative with Your Emergency Fund?
Emergency Fund Investment Options

Start Saving
Many people have no emergency fund at all. If you have one, you’re on the right track. If not, start saving up and you too can have some peace of mind.

An emergency fund should be easily available. The assets should be liquid and the more you depend on it, the lower the investment risk should be.

Savings Amount
The recommendations for how much money you need to save in your emergency fund range from 3 to 6 to 9 months of living expenses, with one person attempting to save 18 months worth. A good minimum is 3 months; then depending on your situation and comfort with risk you can save more from there.

Living Costs
Consider whether your living costs will likely increase or decrease during an emergency period to help you plan the amount you’ll need.

Insurance can be viewed as part of your emergency strategy. A mixture of short or long term disability, auto, home, health, and liability insurance can help offset your risk levels and the amount you need to save in an emergency fund.

Investment Options
The different options that were discussed for where to keep your emergency fund money are a money market fund, your checking account, a high-yield online savings account, and 4 week Treasury Bills.

One other choice for homeowners that are less risk averse is to put your money in a less liquid investment and open a home equity line of credit. You can tap the line of credit immediately if needed then liquidate your investments over time to pay back the money borrowed form home equity.

You can also consider spreading your money over a spectrum of financial vehicles that become less liquid and carry higher returns as you move down the spectrum. For example, have 1 months cash in your checking account, 1 month in a high-yield online savings account, 1 month in 4 week Treasury Bills, then another 3 months in a CD.

Passive Income
When you’re calculating how much to save be sure to consider any passive income you have coming in, which might offset the total amount you need in your fund.

Emergency Fund Wrap Up
Emergency funds are one of those things you never really think about until you need it and then it’s too late. Hopefully, this week’s coverage of emergency funds has answered any questions you might have about emergency funds and inspired you to begin one if you haven’t already. If you have questions that weren’t addressed, let me know through my contact form and I’ll get back to you with an answer.

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Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.

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13 Responses to Everything You Ever Wanted to Know About Emergency Funds

  • stephen

    […] Do you think it’s an overly conservative approach towards emergency funds? What would have been your response to the question? I encourage you to visit this post @ Money Smart Life to leave a comment on the issue. […]

  • db

    Another thing I think people could (should? well that’s up to you) take into account when planning their emergency fund is if they want to have a backup plan for relocation costs.

    Consider the scenario that you’ve lost your job and are having trouble finding work in your immediate area. Without adequate funds on hand, you would be limited in the degree to which you could choose to move elsewhere to follow a better job market. On the other hand if you have money set aside for relocation costs then you can more easily pursue that option.

  • ispf

    This is a neat post! I like your summary, and also reading opinions from so many different perspectives collected in one place is neat!

    About the emergency fund, I agree with Lazy that too much can be bad. Also, as jc pointed out in comments, if you have good insurance, as well as good short term and long term disability coverage, a relatively small liquid emergency fund should tide you over through most mishaps.

  • Ben

    I agree with Henry, a mortgage is definitely a living cost. Even if you sell your home, you’ll still have to pay rent somewhere so it would be wise to factor in some mortgage or rent payment into your calculations.

  • Henry @ Binary Dollar

    Mortgage is definitely a living cost. No question.

  • Sun

    Thanks for the nice summary. I have one question about whether mortgage/loan should be considered as a separate item or it’s included in the living costs. The reason is if you have a mortgage, then the monthly payment should be part of overall spending. You certainly don’t want to lose your house because your emergency fund doesn’t cover mortgage payment.


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