How Much Should I Have in My Emergency Fund test

Posted by: Leo Marte, CFP®, MBA | Apr 11 2022

An emergency fund is the foundation of a solid financial plan. This fund covers unexpected expenses, replacement of essential items, job interruption, and other unforeseen circumstances. In January 2020, CNBC reported that only 41% of Americans would be able to cover a $1,000 emergency with savings. This statistic shows that Americans are highly vulnerable to sudden life shocks.

If you are a Christian hoping to shore up your emergency savings, we have a few general guidelines to help you find the right amount of protection.

How long should an emergency fund sustain your expenses?

Most rules of thumb related to emergency fund size typically come in terms of the number of months of expenses they can cover. That is a reasonable starting point, given that your emergencies tend to be proportional to your cost of living. But how large should your emergency fund be?

One month - This is truly a baby emergency fund and is likely insufficient to insulate you from life’s surprises over the long haul - but it’s a good start. A one-month emergency fund will likely reduce your anxiety from small surprise expenses like a transmission going out or needing to replace a tire. It could also go a long way for medium-sized expenses like a refrigerator or water heater that stops working. This level is where you are likely aiming to be if you are in consumer debt and trying to get out of it.
Three months - This is where you start building some margin in your life and cover significant expenses. An example could be your HVAC stops working or the roof damage from the latest storm that insurance didn’t cover. If you are a dual-income household with stable jobs, you may be able to stop here, as this would likely be sufficient.
Six months - At this level, you start protecting yourself against job disruptions or multiple major expenses happening sequentially. This level is as high as you should aim to be while you are still working and building wealth so that your money can continue working for you. Professionals on commission, self-employed individuals or one-income households will appreciate the extra protection a cushion of this size provides.
One to three years - If you are a retiree with a sizable nest egg, but the idea of stock market gyrations makes you nauseous, you should discuss with your advisor if it makes sense to have one or more years socked away to weather the storm. This buffer can allow your portfolio to grow over time and reduces the temptation to sell when times get tough. This level can also make sense if you run a business that needs additional cash or maintain a rental property portfolio.

Now that you have a good idea of the different emergency funding levels let’s talk about where it should live to provide the protection you need.

Where should it live?

A one-, three-, or six-month emergency fund should be in highly liquid and safe accounts. These accounts allow you to transfer money on demand without the fear of losing it due to market fluctuations. It is hard to appreciate that flexibility when interest rates are low and the stock market is heading for new highs. Still, you will thank yourself when the inevitable decline in the economic cycle puts stress on the economy. Consider any forgone growth on this money as your insurance premium to ensure the money is there when you need it. As a Christian financial planner, here are the typical places I recommend my clients put their money:

Regular bank savings accounts - They are likely the safest and most accessible if you bank locally and with the lowest interest rate. If you value the flexibility of walking into a branch and accessing cash, you may want to consider leaving one month’s worth of expenses at your local bank and put the rest in a different account. These accounts offer FDIC insurance.
High-yield savings accounts - These are typically available from online banks and offer significantly higher interest rates without a branch’s convenience. If you are comfortable banking online and don’t foresee needing emergency cash the same-day, this can be an excellent option for your three- or six-month emergency fund. These accounts offer FDIC insurance.
Money market mutual funds - Offered by every major brokerage firm, they are a highly liquid mutual fund that is usually backed by short-term U.S. Treasury or agency debt securities and strives to maintain a $1/share price without fluctuations. Depending on the interest rate environment, these accounts may provide better or worse interest rates than a high-yield savings account. Money market mutual funds tend to be a popular option with retirees because check-writing is common and makes money accessible without a bank transfer. These accounts are not FDIC-insured, so always check with your brokerage firm to see what protection those funds will have.
Short-term bond mutual funds - A possible option for retirees with six- or more-month emergency funds. You can allocate a portion to obtain a higher yield. Beware that these funds do experience fluctuations, and you may be risking the principal. Like money market mutual funds, these accounts are also not FDIC-insured, so always check with your brokerage firm to see what protection those funds will have.

Leo Marte is a Christian financial advisor and CERTIFIED FINANCIAL PLANNER™. Abundant Advisors provides financial advice for Christians with convenient virtual meetings. Let’s talk if you are ready to make the next move.