The Danger of Making Your Emergency Fund Too Big

Can an Emergency Fund Be Too Big?

If you’ve ever been through a medical emergency, suffered a job loss, or faced other major emergencies, you know that unexpected events are often accompanied by unexpected expenses. Not having cash reserves set aside just for emergencies is poor financial planning that can force you into debt and threaten your financial health.

Having a sizable emergency fund is a good goal. But when it comes to your emergency savings fund, bigger isn’t always better.

Having tons of money in your rainy day fund may give you a sense of security, but it isn’t necessarily the best use of your money. You might not need to put away as much as you think.

How Big Should Your Emergency Fund Be?

Most financial experts recommend having three to six months of expenses set aside for emergencies as a rule of thumb. Three to six months of living expenses is only a guideline. How big your emergency fund should be depends on other factors, including your job security, household income, and health.

If you’re in good health and part of a household with multiple sources of income or you’ve had a steady paycheck for years, a three-month emergency fund might be enough. A six-month emergency fund might be more appropriate if your family is living on one income or you live in a high-cost-of-living area.

Three to six months’ worth of expenses is a good benchmark, but it might not be enough financial security in some cases. Consider saving more if:

  • You have children
  • You’re a seasonal worker, freelancer, or work on commission
  • You have a lingering medical condition
  • The economy is in a downturn or recession
  • You are retired

You would do anything for your children. Sometimes that means spending thousands of dollars on surprise costs you didn’t see coming. Having dependents is a good reason to save more than six months’ worth of expenses.

If you have a variable income, it might make sense to have larger emergency savings. When your paycheck varies, covering common emergencies and replenishing your emergency fund after using it can be challenging. A bigger cash cushion allows you more room.

A 12-month emergency fund might be best if you have chronic health problems or are retired. If you’re enjoying retirement, you probably don’t want to go back to work or tap your individual retirement account or other retirement savings to pay for unexpected emergencies.

During tough times, unemployment rates are higher. It could also take longer than six months to find a job during a recession. You need enough saved to allow yourself ample time to find work.

Is My Emergency Fund Too Big?

The general rule of thumb is to keep three to six months of living expenses in cash in an emergency fund. To determine if your emergency fund is too big, first review your monthly expenses. Then consider your personal and professional circumstances. 

When you assess your budget, focus on how much you need to cover your basic living expenses. Add up your rent or mortgage payments, food, utilities, insurance, debt payments, and other bills.

You don’t have to factor in discretionary expenses. In the event of a real emergency, you can assume you will waste less money. You won’t be budgeting for unnecessary expenses such as restaurant meals or entertainment expenses.

Once you have your necessary spending totaled, you can multiply your actual expenses by the number of months of expenses you want in savings to come up with your emergency fund goal. It could be from three to six months, as most experts suggest. You might need a higher multiple if your family has one source of income or your current income fluctuates.

The next step is deciding if your emergency fund is too big. Compare how much you determined you need with what you actually have.

If your contingency fund holds significantly more than you need to cover your daily expenses for a few months, you can adjust your savings goals. You might put the excess into something with a higher rate of return than a savings account or pay off high-interest credit card debt.

Why Is Having Too Much Money In My Emergency Fund Bad?

Woman withdrawing cash at an ATM.

Where do most people keep their emergency money? The conventional advice is to keep your emergency cash savings in one of the following:

  • High-Yield Savings Accounts: High-yield savings accounts offered by online banks pay higher interest rates than your local bank or credit union. But a high-yield savings account might still offer less than 1% on your money.
  • Money-market Accounts: A money market account pays you interest based on current market interest rates. Local banks offer money market accounts that often come with a debit card and paper checks. There’s usually a minimum deposit needed to open an account and a minimum balance required to earn the best rates.
  • Savings or Checking Accounts: You won’t earn much interest with checking or regular savings accounts at your local bank. On the plus side, there’s typically a low or no minimum balance requirement, your money is insured, and you have quick access to your funds when needed.

All of these types of bank accounts are sensible options. You can easily access your money when a true emergency situation pops up. If you keep too much money in one of these accounts, there are financial consequences, however.

When Your Emergency Fund is Too Big

Black briefcase full of cash.

Having too much in your emergency fund can be detrimental to your financial plan. Here are the dangers of keeping too much money in your emergency fund :

1. Your Money Grows Too Slowly or Not At All

Keeping your emergency money in a savings account separate from the money you use for daily living expenses is smart. The money is insured and easily accessible.

The problem is traditional savings accounts offer low interest rates. That means your money isn’t growing.

That also means your money loses buying power due to inflation over time. What little interest you earn does not keep pace with the inflation rate. As your emergency fund piles up, it’s worth less every year.

2. You Miss Investment Opportunities

You want your money to grow rather than stagnate or lose value. Saving too much money for emergencies may hinder you from growing your money.

Investing is how you make the most of your money. The historical average stock market return of around 7% is several times higher than any high-yield savings account rate and outpaces inflation. You can start investing with the portion of your savings above and beyond what you need to cover an emergency.

Investing does carry some level of risk, while banks give you a sense of security. It’s tempting to leave your emergency fund in savings knowing the balance will never go down unless you make a withdrawal.

Constructing a diversified investment portfolio that matches your risk tolerance is possible, however. You could consult a financial planner or use a robo-advisor for a more hands-off approach.

3. You Stay in Debt Longer

If your emergency savings account is overfunded and you are carrying high-interest debt, you’re missing a chance to make extra debt payments and get out of debt. Paying off debt aggressively means you pay less interest and keep more of your money. Consider using your surplus cash to pay off your credit cards, student loans, or other debts.

If you follow Dave Ramsey’s emergency fund guidelines, you know he recommends building a $1,000 emergency fund first then focusing on paying off debt. Once your starter emergency fund is established and you’re debt-free, Ramsey suggests then working on building a three to six-month emergency fund. If you build your emergency savings as Ramsey recommends, overfunding and not paying off debt won’t be issues.

4. Financial Goals Get Ignored

Instead of focusing on saving for catastrophic emergencies and worst-case scenarios, consider putting your excess cash to better use. You could put your extra cash toward other financial goals like owning a home, starting a college fund, or retiring early.

5. You Miss Out on Tax Savings

Rather than leaving more money than necessary in your emergency savings, you could invest the extra money in tax-advantaged retirement accounts.

You could contribute more to your 401(k) if your employer offers one. You could invest in a Roth IRA. If you have kids, you could gain tax advantages by putting money into a 529 college savings fund.

Having Too Much in Your Emergency Fund

Your emergency fund should give you peace of mind knowing you have an emergency cushion in the bank to handle unforeseen expenses. You never know when your car will break down, your pet will need emergency surgery, a global pandemic will put you out of business, or a major appliance will give out. Having enough saved to cover your monthly expenses in a financial emergency saves you from turning to high-interest credit cards or taking out a loan when unexpected costs appear.

That doesn’t mean you should build a huge emergency fund. You don’t need a $30,000 emergency fund if a $10,000 emergency fund is enough to live on for six months if you lose an income source or face a major emergency.

Throwing tons of cash into a savings account that doesn’t pay a competitive interest rate can result in missed financial opportunities. Once you have a healthy emergency fund, you can turn your attention to other aspects of your personal finances. You can build your retirement nest egg through an IRA, focus on building wealth through other investments, or start saving for major purchases and big expenses.

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