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How big should your emergency fund be? Is 3-6 months enough or should it be more? In this highlight, we discuss how big your emergency fund should be and why.
Jay has a question. He asks when it makes sense to have more than three to six months of an emergency fund. He mentions that he is currently maxing out his 401K, Roth, and HSA, and wonders if he should save more in his emergency fund or pay off his mortgage. He asks how to decide where to put the extra savings.
The answer to Jay’s question depends on the situation’s risk profile. For example, if there are two incomes, then a smaller emergency fund may suffice. However, if only one income is available, it’s important to have a higher cash reserve as the risk is higher. Similarly, if someone is a small business owner or has a high income, the responsibility of pushing the emergency fund up increases.
The most common time when we may need a larger emergency fund than usual is when we’re preparing for retirement or financial independence. As we move into a phase where we rely on our resources, we’ll need a bigger emergency fund. Retirees or soon-to-be retirees may need an emergency fund of 12 to 24 months of liquid capital to manage any market environments they may encounter. They should be able to pull money from their emergency funds without having to sell assets at depressed prices.
Moreover, the yield on cash is getting closer to some people’s safe withdrawal rates, which means it’s okay to run a little fatter on cash. This may lead to a bigger emergency fund. For example, in the past, when interest rates were close to zero, retirees had to push themselves further on the risk spectrum to get appreciation. However, with a good yield on cash, it’s possible to have a bigger emergency fund.
Additionally, running fat on cash reserves can help small business owners or employees who rely on their businesses to be stable. A bigger emergency fund can help prevent fluctuations in the market and economy from affecting them.
In summary, determining the size of an emergency fund depends on the risk profile of the situation. Higher risk requires a bigger emergency fund. People preparing for retirement or financial independence may also need a bigger emergency fund, with retirees or soon-to-be retirees needing up to 24 months of liquid capital. Finally, running fat on cash reserves can help small business owners and employees who rely on their businesses to be stable.
For more information, check out our show called, “3-Month vs 6-Month Emergency Fund: Which Is Right for You?”
