The Right Amount of Emergency Money to Keep in Cash

No matter if you call it, an emergency fund or a cash reserve, the idea is that we all need extra money set aside to stay safe from the unexpected. Not having enough cash on hand to pay for an emergency is why many people get into financial trouble. Having a safety net protects your finances and also gives you peace of mind. 

Life happens, and it usually costs money!

But knowing the right amount of emergency cash to keep can be confusing. Today, I'll answer several questions to help you figure out how much your emergency fund should be, the best place to put it, and whether you should invest it. 

Why have an emergency fund?

An emergency fund is a cash account earmarked to pay for the inevitable and unforeseen emergencies in life. Your car won't start. Your computer crashes. Your refrigerator quits. You get sick. You lose your job or business income. Life happens, and it usually costs money!

When you have an unexpected large expense or your income dries up, you need a cash cushion to fall back on to stay healthy and safe. Otherwise, you'll have to make serious sacrifices or rack up debt on a credit card.

I compare an emergency fund to a moat surrounding a fort or castle to protect it from invaders. An emergency fund helps you stay safe from harmful problems that could invade your financial house. 

In general, it's best to keep emergency savings in an FDIC-insured bank account.

Since emergencies happen in a split second, you need cash in an account you can tap immediately. In general, it's best to keep emergency savings in an FDIC-insured bank account. Emergencies can't wait for a CD or bond to mature or for you to sell a valuable asset or a home to raise needed cash.

What if my savings account doesn't pay much or any interest?

I know that keeping a lot of money in a low or no-interest savings account can seem counterintuitive or feel frustrating. A podcast listener named Tena J. says:

I have a 401(k), and $30,000 in savings not making any interest. I know that I need to put this money somewhere to invest for retirement. What's your advice?

Thanks for your question, Tena. I recommend that you think about your emergency savings and your retirement investments as two separate buckets of money with different purposes. 

Even though we tend to use the terms saving and investing interchangeably, they're not the same. The difference has to do with taking a financial risk. You need an emergency savings account that is kept safe and entirely free from risk so it's there when you need it. But the purpose of investing is to put your money at some level of risk in exchange for future growth. Remember that there's always a tradeoff between financial risk and return....

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