There’s this guideline to having an emergency fund; save three to six month’s worth of expenses (expenses, not salary). The importance of having a cash buffer to fall back on in case of emergencies can’t be stressed enough; however, I do think that there’s a lot to be unpacked in a simple recommendation of “three to six months of expenses”.
Which is more appropriate, three or six months?
If you have no dependents, I think it’s smarter to be closer to three months than to six months. Supporting a family is obviously a different story, but single individuals should have a much higher tolerance for risk. Once the emergency fund is built, why keep adding to it when you can focus instead towards debt repayment and investments?
The truth is, I don’t think I even need to have more than $1,000 in my emergency fund, which I could stretch out to cover a month’s worth of expenses, despite having expenses closer to $2,000. Like in Step 1 of Dave Ramsey’s 7 Baby Steps, the first thing anyone should do is have an emergency fund with $1,000. While Step 3 focuses on expanding that fund, I think that only makes sense for people with large financial commitments. I don’t have a house, a car, or kids. I work in data analytics, which is (at the moment) growing, and I live in NYC, which has above average job opportunities. $1,000 in a savings account is more than enough for me, which brings me to my next point.
Have only what you need in cash, then put the rest towards investments
It doesn’t have to be investments, but it should be at least somewhat accessible should an emergency come up, and also be working for you (by growing). I’m using Wealthfront for my personal investment fund, and I’m throwing all my savings in there as soon as I finish paying off my debt. Why should your emergency fund live in investments? More likely than not, an emergency won’t come up. Any money put towards investments will just continue to grow. Huzzah for compounding interest!
Everyone has their own emergency fund number
You are in your own unique financial situation. Obviously, that will affect how much you actually need to have as a cash buffer. If you need six months, so be it. Just make sure that you’re accounting for necessary expenses – that doesn’t include your gym membership and Whole Foods shopping. Another factor to account for? The amount of time it takes for you to replenish your emergency fund if it’s depleted. The higher your savings rate, the less you need in your fund. Why? If it’s easy to save up a month’s worth of expenses in just a few paychecks, then you’re already doing a great job. Also, if you have a high savings rate, chances are, you already have an emergency fund, even if you don’t call it that.
Point is, there’s no need to actually have six months of expenses in the bank if you don’t actually need that much. In addition, you definitely don’t need to have all of your emergency fund in a checking or savings account.
Wait, let’s not get too crazy
Quick caveat. Because the stock market goes up and down, you have to allow for some risk if you’re parking your cash outside an FDIC-insured account. I think it’s worth it, but it’s not for everyone. It’s something to think about. Be smart with your money, but take advantages of growth opportunities when possible.