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That’s a common question, because believe it or not, having too much in your emergency fund can be as troublesome as having too little. Let’s talk about what is an emergency fund, how much should it be, and where should you keep it.
What is an emergency fund?
An emergency fund is an amount of cash that an individual or family will keep on hand in case of an emergency. (Pretty obvious, huh?) The goal of an emergency fund is to have some cash available for when you need to replace a tire, make a trip to Urgent Care, or take your dog to the vet after she eats your daughter’s entire chocolate birthday cake and needs to have her stomach pumped (that may have happened to us to the tune of $429 … the dog is fine). A fully-funded emergency fund can bridge the gap in the case of a surprise job loss, a medical circumstance that leaves you unable to work, or a broken heating and air system.
How much should it be?
It depends on your circumstances.
If you are just starting out as an independent adult without any dependents and living in a rental, $500 – $1,000 is a good starting-out emergency fund. That amount of money is generally enough to cover the kind of emergency you are likely to have: a small medical emergency, a moderate car emergency, or airfare if you need to urgently fly to a funeral. More is better, but $500 to $1,000 is a good place to start.
On the other hand, if you have a family, dependents, a house … you should strive to have a fully-funded emergency fund of three to six months of household expenses. When your life-stage includes dependents and a house, the size and scope of your possible emergency become larger: replacing a leaky roof, replacing broken heating and air system, a trip to the emergency room for a broken bone.
Where should you keep your emergency fund?
The point of your emergency fund is for the money to be readily available in the event of an emergency so it should be kept very liquid and easy to access. By “liquid” I mean “not in an investment”. The job of your emergency fund is NOT to make you money; its job is to be waiting for you when an emergency happens! A high-interest savings account or a money market account are good choices; you can make a little bit of interest on the balance while still having the funds easy to access. You may want to keep some of your emergency fund in your house, just make sure you keep it far away from the “pizza” money (you don’t want to confuse the two).
Is a health savings account (HSA) the same as an emergency fund? Basically, “no”. The money in an HSA can only be used for a medical emergency without incurring penalties and income taxes and many types of emergencies are not medical emergencies.
Can you have too much in your emergency fund? Yes. Because you will keep your emergency fund very liquid, accessible, and not in an investment, you want to make sure it is the “right” amount. If you allocate too much to your emergency fund, you will miss out on investing those excess funds. Managing your money well means that you have a proper-sized emergency fund and assign the rest of your money to other savings, investing, spending, or giving goals.