Money Question – Can You Save Too Much in an Emergency Fund?
April 23, 2007
Any personal finance book or website that’s worth reading will recommend that you save up some amount of money for rainy days; otherwise known as an emergency fund.
Recently a reader wanted to know how much money was too much to save and the best place to keep the money so it wouldn’t be idle:
“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?”
I asked my blogging buddies for their take on the question and received a variety of answers. I’ll publish their thoughts on emergency funds over the next several days. Today we’ll hear from Henry and the Lazy Man.
Lazy Man @ Lazy Man and Money
I’m going to make an assumption here that the emergency fund is making around 2% after inflation. This seems to be the case with the popular options such as online banks that pay high interest rates.
With that assumption in place, I say that you most definitely can have too much money earning a paltry 2%. With common stock historically returning a 6%+ on investment after inflation, it’s a better place to be in the long term (in my and many other’s opinion).
So where is the best place to keep your emergency fund? For probably the vast majority, the online banks that earns high interest is the way to go. For those who are home owners and comfortable with a tiny bit of risk, I would suggest looking into using a HELOC for your emergency fund. Many people would find the idea of using your home’s equity as an emergency fund crazy. Is it that crazy though? Many people use it for non-emergency situations like home improvement.
Why the HELOC? If you define your “emergency” criteria enough, the vast majority of the average person’s life is going to have very few of them. With any luck, true time of using emergency funds should be less than 5 years. I’m picking that number out of a hat, I didn’t do extensive research. If that’s the case, would you rather pay a tax-deductible 8% (a realistic 6% after tax savings) for years, making 6% for another 55 years of a projected adult life? Or would you rather make 2% for 60 years of projected adult life? I’ll take the former.
Henry @ Binary Dollar
I suppose it’s possible to save too much in an emergency fund but it’s unlikely. If some dude gets in a car crash, would he have:
1) money for a new car in case their old one gets wrecked?
2) money for medical expenses?
3) money for living expenses?
He’d be saving too much in his emergency account if he could cover all of these pretty easily. Unless they have that kind of dough stashed away, most people won’t have to worry about saving too much in their emergency account.
Emergency Fund Options
Henry brings up a good point; many people have a difficult time putting away money for an emergency fund so its unlikely that majority of people would be saving too much. However, if you do have the resources and discipline to build up an emergency fund Lazy Man gives an option for homeowners to get a better return on investment on the money you have saved while still maintaining easy and fast access to cash in the event you need it. What are your thoughts?
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