If you have an emergency fund of just $500, congrats; you’re better-off than about half of the population (is anybody else freaked out by this?). But having too much cash on hand to help with life’s curveballs can also hinder you from making the kind of progress you’d like to see over the longer term.
In Total Money Makeover, Dave Ramsey is a huge proponent of having $1000 for emergencies while you aggressively pay off any debts you have. A thousand dollars should cover many of life’s immediate challenges, but once you’ve got your debt paid off it’s a good idea to save for more. If you lose your job you could find yourself out of work for a period of time. Depending on what you do for a living, that period of time could differ. So, logic would follow, there’s not really a one-size-fits-all approach.
Typical advice when you’re finally really building up your EF is to aim for at least 3 months’ worth of expenses. Figuring this out is pretty simple. You’ve made your budget already, so simply multiply what you’re spending each month by 3 and then you have your number. If you’re spending $2500/month, then your goal is $7500.
If you are in a line of work that’s particularly difficult to find a job in, your income fluctuates a lot (for example, a self-employed CPA who gets a majority of his income in just a few month period around tax season), or if you’re worried that the primary bread-winner may lose his or her job for whatever reason, it’s probably a good idea to have a bit more than 3 months’ of expenses saved up. As a baseline, 6 months should be enough to weather anything bad while you get back on your feet.
Of course, this tactic does over-generalize a few things, and that’s not necessarily a bad thing. When you’re making your budget, you likely are accounting for at least some amount of discretionary/fun money (maybe 30% if you use the 50/30/20 budget, for example). If it all hits the fan, chances are you can go a few months without at least some of that. Maybe you lose your job, and decide that until you find something new, you won’t be going out to eat anymore. This can let you stretch your 3 or 6 months a bit longer than you maybe anticipated, which is a good thing. Much better to over-estimate than under-estimate. Making sure you review your budget and your actual spending monthly is a good way to ensure you’ve got at least the 3 month thing covered.
Having more than six months of expenses in a savings account can be both positive and negative. If you’re considering a career move, for example, having a larger buffer can help you mentally take the leap you may be needing. But idle cash isn’t likely to even keep very good pace with inflation. For that reason, after you’ve got enough in the bank so that you can feel comfortable with whatever happens, it’s better to invest that money in something that’ll earn returns that are more than a percent or two. Some of my favorites are:
- Open a brokerage account and invest in low cost index funds
- Peer to Peer (P2P) Lending (such as LendingClub) can be a great way to help others and earn a decent return at the same time. I’m at a bit over 8% since I opened my account with them about 3 years ago, even with a few charge-offs.
- If you want to invest in real-estate without the hassle of being a land-lord, check out Fundrise or RealtyShares. These platforms let you invest in real estate projects throughout the nation
- Use some of it to start a business. You can start a blog for dirt cheap.
- Open an IRA
- Bump up your 401(k) contributions
There are tons of other things you can do with spare cash. Those are just some of the easier ones to get into.
How big is your emergency fund? Is it at your goal amount? And what is your favorite thing to do with the extra?