How Much Should I Save for Emergency Fund?

Should I save for an emergency fund? They told us that we need an emergency fund but do we really need it and if so, how much is too much for an emergency fund? I will share the opportunity cost of having an emergency fund, whether I am overfunding or underfunding my emergency fund, and the best types of accounts for storing my emergency fund.

The question is simple. 

Do we really need an emergency fund? 

Having one will cost me money until I need it. Much like having car insurance, most people agree having car insurance is smart but there are tons of different providers, each with different levels of insurance and different costs. It is the same with an emergency fund. 

I could overdo it. I could underdo it. Or I could put it in the wrong account. 

I’m going over the best practices for my situation by looking at three factors: 

  1. Cost

  2. Amount

  3. Account 

On the go? See my video HERE.

Cost

The first thing I want to tackle is cost. 

I used to think that there was no harm in overstuffing my emergency fund.

It’s not like I’m losing money, right? 

Well, that was wrong. 

Turns out I am losing money in the form of opportunity costs if I put too much money in there. 

After calculating how much money I need in my emergency fund, which I’ll go over that shortly, I need to put it in a stable account. 

I can’t invest it in the stock market because the market could crash at the same time I need to withdraw my money, which is absolutely plausible because market downturns are often correlated with unemployment.

Bad things tend to happen in combination, like a karma combo

Anyway, I have to put my emergency fund in a stable account so that I’m not forced to sell my investments when the market is temporarily down. 

That being said, I do get less gains in a high yield savings account instead of the stock market, and that difference in return is the opportunity cost that I’m talking about.

For instance, I can get a little bit over 5% yield on a stable account at the moment, and I’ll go over which account I use at the end, while the S&P 500 gets an average annualized return of about 10%

That’s a return difference of 5% every year, which will add up. 

Opportunity cost illustration by author

Let’s put this into numbers.

  • If I put an extra $10,000 in a high yield savings account, that money will return about $6,000 in 10 years. 

  • However, if I invested that extra $10,000 in the S&P 500, then it would return roughly $16,000 over the same time period. 

That’s a $10,000 cost on an extra $10,000 in my emergency fund, which is a significant amount of money.

Definitely enough cost to motivate me into taking a stab at calculating how much money really needs to be in there. Clearly too much in there will cost me and obviously putting too little in there could cost me as well

Let’s take a look at the second factor. 

Amount

So how much money should I put in my emergency fund? 

The way I like to make this calculation is by looking at a few different emergencies that I could reasonably experience and then determining how much money I need to cover that emergency. 

Losing My Job

First, let’s calculate losing my job. 

I really only need to answer two questions to determine how much money I’ll need for this emergency. 

  1. How long is it going to take me to find a new job? 

  2. And how much money am I going to spend during that time?

Of course, this will vary quite a bit for y’all depending on the type of job you have. But for me, I think I could get it done in one month but I’m going to play it safe and say I need two months to get a new job. 

Next, to determine how much money I’m going to spend during that time, I simply take a look at my monthly budget, but I do not factor in all of my expenses. I just really look at the bare necessities. 

How much do I need to pay my mortgage, utilities, phone and internet, a little bit of food, and then transportation? 

My monthly and yearly budget

Essentially, what do I need to not lose my house and then be able to job hunt? 

For me, this comes out to about $2,500 each month for two months for a total of $5,000.

Repairing my House

A second major emergency could be a house emergency. 

A storm hits and takes out my roof. And then every time it rains, I’m going to get more damage which is going to cost me more money. The most efficient way to deal with this is to take care of it as soon as possible. 

This is where the emergency fund comes in.

For my home insurance, my deductible is $7,500. This is how much money I would need to cover a house emergency. 

Repairing my Car

I might get into a car wreck. 

The deductible for my auto insurance is $1,000

Getting Sick

I could have a health emergency if you don’t clap for this article (wink).

The deductible for my health insurance is $5,000

Having Major Life Events

I could have a death in my family. 

The average cost for a funeral is $7,000

Okay, this is getting pretty dark… Unless I hurt myself crashing my car into my own house, probably not going to have to deal with many of these at the same time. 

Trying to cover too many emergencies will result in a higher opportunity cost while the odds of it paying off, which is weird to say, are astronomical. 

I simply pick two:

  1. Losing my job 

  2. House emergency

My emergency fund categories

For me, an emergency fund of $12,500 is plenty. 

Amount

Next, I need to decide what account I’m going to put it in. 

And yes, I do feel strongly that it needs to be in a separate account. I like to give every dollar a job.

  1. Checking account dollars can be spent on anything

  2. Investing account dollars cannot be spent at all until I have enough money in there

  3. Emergency fund dollars can only be spent on an emergency

The best way to make sure this happens is to have separate accounts for each thing. Also, checking accounts rarely have the best interest rates anyway.

There are two factors I’m looking for in an emergency fund account. 

  1. I’ve got to be able to withdraw the money at a moment’s notice without penalty, so CDs and bonds are out of the question. 

  2. I’m looking for the highest yield possible, that way I can reduce the opportunity cost as much as I can.

In my opinion, money market accounts and high yield savings accounts fit the bill perfectly. 

My high yield savings account with CIT bank

At this time, you can easily get over a 5% yield in either of these accounts. My high yield savings account is with CIT Bank which is currently yielding 5.05%. It’s not the highest yield out there, but I’ve been using them for a while.

One great thing about having an emergency fund yielding 5% is that it should generally keep up with inflation

Over the years, you will need more and more money in there to maintain your spending power. I like to let the returns stack up until I have a major change in my life. And at that point, I will re-evaluate my emergency fund.

One aspect of creating an emergency fund that I shared earlier was using my budget to simply determine my monthly expenses. I have benefited so much from creating a proper budget for myself. 

In the past I always found it very tedious to create the budget, track my expenses, and keep up with it month after month. But I have finally come up with a system that makes tracking my budget and spending as low effort as possible. 

If you’re interested, click HERE to see my automated budgeting system.

Catch you on the flip side.

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