How Much Emergency Savings Is Enough?
There may come a point when you risk going overboard with your savings.
- It's a good idea to build an emergency fund to cover three to six months of living expenses.
- Socking too much money away in the bank could stunt your money's growth.
The pandemic taught a lot of people a hard lesson about the dangers of not having any savings. And so in its wake, many Americans are making a solid effort to build up some cash reserves.
As a general rule, it's wise to have enough money in your savings account to cover three to six months of essential living expenses. If you're self-employed and therefore not generally entitled to unemployment benefits in the event of job loss, you may want to aim a little bit higher.
But ultimately, there is a limit as to how much money you need to keep in your emergency fund. And if you go overboard, you could actually end up hurting yourself financially.
How much savings is too much?
The benefit of keeping cash in a savings account is that your principal balance is protected. Deposit $20,000, and you won't lose a dime of that $20,000 unless you actually take withdrawals from your account.
The downside of keeping cash in a savings account, though, is earning minimal interest on your money. This is especially applicable in today's environment, when banks are paying such little interest it's almost negligible.
It's for this reason you really don't want to go overboard with your emergency fund. If you keep too much money in the bank and don't invest it, you'll stunt its growth -- and limit your ability to accumulate wealth over time.
Now there's a big reason you should not keep your emergency fund invested in a brokerage account. If you need to take a withdrawal at a time when your investments are down, you'll lock in permanent losses. But once you have a reasonable amount of money socked away for emergencies, you should explore your options for investing the rest.
How to calculate your emergency fund
To figure out what your ideal emergency fund should look like, add up your essential monthly expenses and multiply that figure by three to six, depending on how much protection you want to buy yourself. Remember, you don't need to include non-essential expenses in that calculation. If you normally spend $500 a month on leisure, that's something you could eliminate for a few months if you're out of work -- whereas you can't eliminate your car payments or grocery purchases.
So, say you spend $3,000 a month on essential bills. In that case, an $18,000 emergency fund should more than suffice.
If you're self-employed and want to pad that number a bit -- say, by a few thousand dollars -- go for it. But should you be stashing away $40,000 for emergency fund purposes if you only spend $3,000 a month on essential bills? Probably not. Instead, you may want to keep $20,000 in the bank for emergencies, and invest the remaining $20,000.
Having emergency savings is unquestionably important. And it can also bring you peace of mind. But there is such a thing as keeping too much of your money in cash, and that's a trap you'll want to avoid.
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