A question almost as divided as politics. If you were to ask 10 people how much they think they should keep in savings, you will likely get different several different answers. Even the experts disagree on the subject and have their recommendations. Those at Ramsey Solutions recommend 3-6 months worth of expenses, while Suze Orman is more conservative and recommends 12 months. When I work with people, I often tell them that like most things in life, the answer depends.
The recommendations from experts all aim to give people a safety net for unexpected life events. If you were to lose your job or have an unexpected health emergency, you want something to sustain you in the short term. One of the most important aspects of an emergency fund is liquidity. This is how quickly you can leverage your money to pay expenses. In an emergency you don’t want to have all your cash tied up and incur any late payments. This is what draws so many people to keep their emergency funds in a savings account or money market account. You can easily move funds to a checking account, or even write checks directly from these accounts.
The drawback to savings accounts is that your money is eroded by inflation. While banks insure up to $250,000 through the FDIC, the interest rates tend to be significantly lower than the market where higher returns are found. I call this a safety tax because you have protection on your money but you lose value long term. If inflation is 5% but a savings account only generates 3% interest, your money is losing 2% of its value compared to the market. This is not ideal, but what options do we have?
I recommend people evaluate the risk in their job as well as the household. If you are a dual-income household and the odds of both earners being unemployed at the same time is low, you can get away with a 3 month emergency fund. If you have highly volatile work or seasonal work, or if you both work at the same location, you may opt to have a more conservative amount like 6-12 months. I also recommend analyzing your budget to understand what your necessary costs are versus your discretionary costs. Your budget may typically be $5,000/month as an example, but if facing a layoff of emergency you could likely skip certain expenses to bring that cost down. So instead of saving $15,000 for a 3 month emergency fund, you could probably get that down to $10,000 or lower.
The other topic I cover with people is what types of cash do you have at your disposal? One client I have worked with has virtually nothing in their emergency fund because they have access to credit and investments. In their instance they can use a credit card to pay for immediate expenses while they liquidate some of their investments and pay off the short-term debt. So instead of having $20,000 earning 5%, they are earning closer to 11% in the current market. I will say there are some caveats to this strategy and it is not something I would recommend for everyone. This client is very disciplined in their spending and does not rack up debt on credit cards, and they understand their expenses very well. One thing they cannot pay with a credit card is their mortgage, so they have to have some cash on hand but not a lot. There are companies like Plastiq can pay through a credit card, but their fee basically wipes out any earnings you would get compared to just having your money in savings.
So at the end of the day, each person or household should evaluate their situation and make a choice that is unique for them. As a rule of thumb I would aim to keep the amount in savings as minimal as possible while still meeting your needs and timelines. If you have investments in brokerage accounts you have a bit more liquidity than real estate that could take months to sell. This could mean a smaller amount in savings compared to the latter option. I would also note what expenses you could suspend and which are required to pay. Many services (internet, cell phone, television, landscaping, etc) can be paused in an emergency and resumed when you have stabilized.
