It’s hard to overstate the importance of an emergency fund. If anything unexpected happens in your life, whether it’s an illness or death in the family, a job loss or out-of-the-blue car repairs, access to cash when you need it most can mean the difference between taking care of the issue with minimal stress and going deep into credit card debt.
According to a 2015 Federal Reserve’s Report, 46% of Americans don’t have the cash on hand to pay even $400 in the event of an emergency. If this describes you, don’t be afraid to start small! Building up your emergency fund to $1,000 is a very worthy goal. Contributing $25 a month or even $3 a day is much better than nothing. Every little bit can help in a crisis.
But did you know you can also have too much cash in your emergency fund? If you simply leave it in a savings account, you’re not making the most of your money because it isn’t growing.
Today we’re helping you decide whether you have too much cash in your emergency fund – and if so, what to do with that money instead.
How Much Should Be In Your Emergency Fund?
Most financial experts agree your emergency fund should cover between 3 and 6 months’ worth of living expenses. Keep in mind that if layoffs are common in your field, your income is irregular, or you’re a retiree, your specific situation may call for more of a buffer.
Once you’ve settled on how much time you’d like your emergency fund to cover, it’s time to decide how much money that actually means for you.
First, calculate the costs for your must-have expenses:
- Rent or mortgage
- Health care (including insurance)
- Other personal expenses
Next, use more conservative estimates for the kinds of expenses you’re likely to cut back on (or eliminate altogether) when an unexpected life change happens:
- Dining out
- Savings for other financial goals like a second home or college
Is There Too Much in Your Emergency Fund?
You need the money in your emergency fund to be quickly accessible. To make this possible, you likely keep it in a savings account where it only earns around 1% in annual interest (and that’s on the high end) which doesn’t even come close to outpacing inflation.
You’re actually losing money if you store too much in your emergency savings. You’re missing out on contributing to retirement, paying down your debts, or saving up for a down payment on your dream home. You’re missing out on opportunities if you don’t give your money the opportunity to grow.
Put Your Extra Cash To Better Use
If you run the numbers and find you have some money in your emergency fund to spare, consider putting at least some of it into an IRA. In 2017, you’re able to put as much as $5,500 per year into one of these accounts (if you’re 50 or older, the limit is $6,500).
For your future contributions, you have at least two options:
If your employer offers a matching program for your 401(k) contributions, make it a priority to contribute enough to earn the full match.
If you don’t have a 401(k), your employer doesn’t have a matching program, or you’re already contribute enough to max them out, the IRA could be your best option. If you choose a Roth IRA rather than a traditional, there’s an added advantage: in case of a true emergency, you can dip into it and use your contributions, because Roth IRA rules let you withdraw contributions anytime. Keep in mind this isn’t ideal, though!
Your Emergency Fund is For You
At the end of the day, you’ll want to have enough money in your emergency fund to make you feel secure and to serve as a buffer between you and life’s unexpected twists and turns. Run the numbers, then trust your gut – and don’t be afraid to make the most of your money.
*Disclaimer: Citywide Home Loans does not provide financial planning services or any other service apart from lending. You should always consult with your legal, tax and financial advisors to determine which strategy is the most suitable for your specific circumstances.