Can You Save Too Much In An Emergency Fund? What Do You Think?

by golbguru on April 27, 2007

Recently, Ben @ Money Smart Life ran a series of posts on “Can You Save Too Much In An Emergency Fund“. The purpose of the series was to answer this question posed by a reader:

“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 contributed a quick response to the question and it looked like this:

Let me start with the basic idea of an “emergency fund”. According to my definition of the concept, it’s a pool of money to account for *unexpected* circumstances and must adhere to the following three requirements:

  1. It should easily available in an emergency (must be liquid and easily accessible through common instruments like cash or checks).
  2. There should be a sufficient margin of safety built into it (a part of my answer to the question lies here).
  3. It should be held as risk free as possible (you don’t want a devalued pool of investments right at the time of an emergency).

So is there such a thing as too much emergency fund?
I look at emergency funds as a sort of foolproof “hedge” against unforeseen circumstances. For example, it is like a cushion to break your fall and allow your survival if you lose a job (unexpectedly), or if the stock market crashes and you lose a major chunk of your net worth, your house catches fire and your insurance company messes with you and delays payments….things like that. Agreed that these things don’t happen on a regular basis…but they need to happen only once in your lifetime to make you realize the importance of a cushion. So ideally, your emergency fund should be able to cushion the worst possible scenario (specific to your personal situation) that you can imagine (update: “end of the world” is not a valid scenario). Add a 20% margin of error to that estimate (roughly) and aim for that emergency amount. The right amount will be something that makes you feel “safe” after considering the worst case scenario. More than that is probably “too much”. Of course, the measure of “too much” will vary greatly depending on your lifestyle.

Where to park the money for maximum returns?
Since I view emergency funds as ‘hedge’ ..returns on these funds are not a major concern. I would first satisfy the above three requirements and then maximize my returns from the available choices. Online savings accounts with ATM and/or check facilities are one of the potential places to such park funds. If you park your funds in such a place where the funds are not easily accessible, make sure you have an instrument of equivalent value available for use (for example, you could use a credit card at the time of an emergency…and then repay it as soon as you get your funds at a later time).

I understand that I have a more conservative (almost a bit paranoid) approach towards this issue. However, due to the “unforeseen” nature of emergencies, it does merit some consideration.

Do you think it’s an overly conservative approach towards emergency funds? What would have been your response to the question? I encourage you to visit this post @ Money Smart Life to leave a comment on the issue.

I thought a bit more on this issue after leaving my response and came up with some additional stuff.

Technically, with increasing emergency funds, you are opting for greater security and lesser returns - sometimes this makes me think that there really isn’t any “too much” when saving for emergency funds; what you lose in returns you will gain in stability/assurance/security. I sketched a quick schematic to illustrate my point:

risk emergency funds relation

Note that the term “Increasing Returns” in the above graph is only valid under the following assumptions:

  • Emergency fund is assumed to be highly liquid with low returns.
  • If you choose to keep a small emergency fund, you are diverting a large portion of your money into high yield investments.
  • If you choose to keep a large emergency fund, you are diverting a smaller portion of your money towards high yield investments.

Hope that makes sense.

Another thought is that I don’t consider insurance as an *emergency* fund..however, some people tend to think that way. Insurance is very situation specific (it’s not economically feasible to insure every aspect of your life) and there can be incredible procedural delays in getting your money through a claim. In fact - like I said before - your emergency fund should fill in that gap caused due to a procedural delay (and/or eventual dismissal) of your insurance claims.

I have some more observations on this issue, but I don’t want to clutter the post with too many lines of thoughts, so everything else will have to wait.

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{ 26 comments… read them below or add one }

1 John Wilks 04.27.07 at 9:42 am

I tried keeping an emergency fund in physical paper money in my fireproof file cabinate, but I just hated not earning interest.

Now I stick my emergency fund in my online HSBC direct savings account. It comes with an ATM card so I can get to my money from almost any ATM in the world. It’s $1.50 to use the ATM card. However, if there’s no electricity to power the ATM machine or the internet deletes itself… well I guess we would all be in bad shape then and emergency money would be the least of my worries.

2 oneway 04.27.07 at 9:42 am

Great post! :)

3 Lisa 04.27.07 at 10:10 am

Emergency funds are a source of comfort for me. Personally I keep the majority of my money in an online savings account. The total is almost to where I feel comfortable. Everyone has a different comfort level.

Now, I will keep the total to myself, as my husband will want to spend it if he really knew how much I had put away. That is another reason why having money put away “just in case” gives me piece of mind.

At the house I will keep about 500 dollars to 750 dollars tucked away in various places. Again, this makes me secure knowing that I can get my hands on “real” money.

Everyone feels different about their money, and an emergency fund is whatever makes you comfortable.

4 Missy 04.27.07 at 10:12 am

To add another thought, I am a big fan of spare change jars. I love the fact that the money, ( however much ) is there if I need it. And again, I will have several jars of spare change around the house.

This “thing” about having money “near” me probably stems from childhood, but that is another story.

5 zen 04.27.07 at 10:15 am

I’m with John Wilks - I use HSBC for my emergency fund. The ATM card is stored in a safe place, the money gains interest, and I’m not liable to use it.

6 moom 04.27.07 at 10:16 am

I regard capacity to borrow against assets as an emergency fund:

I have about $88k in borrowing capacity for non-investment purposes.

Otherwise my liquid cash varies from very little to maybe $15k or so. The main thing is one needs to have significant assets outside retirement accounts. Most PF bloggers seem to go to the max out retirement accounts route for perceived tax benefits and that’s a mistake before you have significant non-retirement assets IMO for many people. Of course many have the capacity to borrow on a HELOC or whatever, but many don’t.

7 Sharon 04.27.07 at 11:25 am

Glad to have my thinking cap on this morning….. Your spam protection just asked me a question to add 3+1.

As you can tell, I’m so lousy with math that involves currency, so Lem is my “hedge” fund (master of the castle). I give him my money, and I swear he’s told me many times that its accumulating interest.

Must ask him where he hides it…. :)

8 Q 04.27.07 at 12:13 pm

I do not maintain such a fund. I keep minimal cash around. Having cash just sitting around drives me nuts; I can’t help myself.

If an employment-related emergency ever arises, as a CPA I should be able to start generating cash for the family pretty quickly. For this or any other money-related emergency, I would lean on our Home Equity Line of credit. It currently stands at $46,000, 1/2 for a downpament for a lakehouse, the other 1/2 for the purchase of a minivan :-( I have $39,000 available to borrow on it, and would tap it if I had to.

9 golbguru 04.27.07 at 1:22 pm

Do I see a difference in the approach towards emergency funds between homeowners and apartment dwellers?

Both Moom and Q seem to bank on HELOC “leverage” - it’s kind of using your equity in the house as a leverage to generate emergency funds, while the rest of them are tending towards liquid cash.

Know any homeowners who shy away from HELOC and tend towards cash/savings?

10 Lemuel Jopio 04.27.07 at 11:02 pm

When it comes to managing my rainy day fund (a.k.a. Emergency Fund), I used to put away 2 to 3 months worth of income to cover my necessary expenses. Since Imaginary Diva and I are now married, our rainy day fund has been increased to last 4 to 6 months.

As a self-employed individual, these measures are within my comfort zone. Plus, it pays to be prepared if anything happens to either of us.

11 Financial Jungle 04.28.07 at 12:14 am

Having cash around doesn’t comfort me because I know that one dollar in cash is one dollar less in the mortgage to save tax-free interests.

When you hold cash, mortgage interests are guaranteed. When you pay down the mortgage with the cash, HELOC acts as your emergency fund. The most likely scenario is you won’t touch this fund, so you’ll likely save on the mortgage interests. If you do touch it, you’ll pay prime rate which is slightly higher than variable mortgage rate. Note this is the worst-case and improbable scenario. Interests on HELOC can be re-borrowed, so the cash-flow is identical to holding cash.

12 db 04.28.07 at 12:46 am

why are homeowners so smitten by the HELOC? It’s still a loan, even if it is against yourself.

We hear a lot of talk about how it’s a bad idea to borrow from your 401(k), which is another form of borrowing against yourself. I have to wonder about the wisdom (vs. the convenience) of borrowing from your house equity.


13 green 04.28.07 at 6:26 am

I’m thinking the same way as the article states.

14 Financial Jungle 04.28.07 at 7:49 am

HELOC is a only loan if you borrow from it, otherwise it’s just an available credit for your emergencies. While you are not using it, it’s saving you mortgage interests.

15 db 04.28.07 at 7:09 pm

Of course another way to save mortgage interest is to pay down your mortgage.

I still don’t see any attraction to borrowing against the equity of your home. It seems like financial self-cannibalism to me.

16 hs2o 04.28.07 at 7:20 pm

So HELOC is like a line of credit? Why would anyone rely on a line of credit? If there was a national emergency, the banks would not be able to honor that line of credit, and you would be left depending on whatever cash you had around you. If it was a family emergency, that’s like putting it on a credit card. I already have a credit card to do that! Or is HELOC interest free?

I think we are often very short-sighted and only see an emergency as one generated within our own home. I like to consider emergencies from all sources, including national level ones.

We keep about $1000 in the house in cash in various places. Plus we bank at 3 different banks, and have retirement plans in separate locations. We use everything from a standard savings account, chequing account to money market fund, and more aggressive mutual funds.

This diversity of money management serves as our hedge against an emergency, whether generated by us or someone else.

17 Financial Jungle 04.29.07 at 9:46 am

There are different levels of emergency funds, and I agree that having say $1000 cash in the house is a smart idea.

Beyond the $1000 cash, paying down the rest of the cash against the mortgage and use HELOC as “plan B” is prudent.

“I still don’t see any attraction to borrowing against the equity of your home.”

Then you must agree having HELOC is a good idea, because the alternative is exactly what you just described above. If you have $5,000 cash laying around as emergency fund, you’re effectively not paying down your mortgage by $5,000 or effectively borrowing $5,000 against your equity of your home as you described.

At least if you pay off that $5,000, you are saving the mortgage interests while you’re WAITING for the emergency to happen.

18 db 04.29.07 at 2:58 pm

No I don’t agree that the HELOC is a good idea, I think it’s an incredibly stupid idea. I think the only smart idea is to go work a little harder and get another $5,000 to also pay against your mortgage, all while keeping your current $5,000 safe for an emergency.

19 Financial Jungle 04.29.07 at 3:23 pm

You have to be consistent with you rationales. First you said don’t borrow against the equity of your home, so I agreed with you by suggesting to pay down the mortgage and have HELOC on standby.

Now you’re saying you rather owe the mortgage and have $5,000 safe under your matress.

20 Super Saver 04.29.07 at 6:07 pm


As long as the funds can have multiple uses, I don’t worry about the emergency fund getting too big.

I find that the same money can serve as emergency funds, future large purchase (example car), or home down payment. That’s because not all of them will happen at the same time. And if I have an emergency, then I would delay my car or house purchase by using the funds.

21 Cheryl 04.30.07 at 6:40 am

I have my efund in an online savings acct, and I am not under the assumption that one can have “too much” in an efund. You never know what is going to happen, and I prefer having a safety net. I am also a “change jar” person…I have 2 of them in the house, and throw all spare change in at the end of the week, when it’s full…off to the bank it goes!

22 Ted Valentine 06.06.07 at 12:40 pm

Regarding HELOC — I have a substantial HELOC (>$20k) and I have a balance of $0. I also have an emergency fund in a money market account of 5 months living expenses. The HELOC was opened when we bought the house to give us flexibility and I look at as my last line of defense to keep from having to sell the house.

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