Where I Put Our Emergency Money

Ben at Money Smart Life is hosting the second edition of What’s Your Money Question? this week (the first edition is right here) and this time the questions asked is

Is there such thing as saving too much money in an emergency fund? What’s the best place to keep the money you do save so it still earns you something while just sitting there?

There are lots of discussions on why an emergency fund is the foundation of personal finance. Before starting investing your money in the stock markets, you should have a safety net to protect your assets. As for how much is enough for an emergency fund, a commonly accepted standard is that you should have no less than three months’ worth of money to cover your daily expenses, including all your obligations such as mortgage, loan, and insurance, etc. The total amount then is your average monthly spending multiplied by number of months you need to go through the uncertain period.

Now back to the question: Can one save too much in an emergency fund? My answer to this question is: Yes, that’s possible. The problem isn’t really that one saves too much money, but rather the money treated specially as emergency fund could be too much. Since an emergency fund is the money that you set aside for unexpected events, the money should be held in places like bank checking account, savings account, CD, or short-term Treasury bills that are easily accessible. This means you can’t use your emergency fund to make long-term commitment such as investing in stock markets. Historically, however, stocks provide much higher return than other investment vehicles. Thus, one can risk of losing money by putting too much in short-term investments than letting the money participate in stock markets. In my opinion, 3-month is the minimum, 6-month is adequate, 12+-month isn’t really necessary.

That being said, like any other personal finance issues, how to create an emergency fund (or whether or not to create one) is very personal. There’s no formula to tell you how much is enough and it also depends on what you consider as an emergency. For us, the biggest worry is loss of jobs, but that’s hardly considered as a true emergency. If we lose our jobs today, there will still be foods on the table tomorrow. Our emergency money is to prepare for the situation in which it will take several months before we can find a new job.

In answering this week’s money question, here’s what I do with our emergency fund:

1. Checking account

I put around $5,000 in the Bank of America checking account that we can withdraw immediately. These money is used to cover our living expenses and the account is account is refurnished twice a month from our salaries. I couldn’t imagine any situation that requires thousands of dollars right away, thus it doesn’t make sense to have more than necessary in a checking account that earns nothing. If all the sudden I need to pay a big bill, I assume in most cases I can charge with my credit card. As long as I can pay with credit cards, I am not worried about the cash in the checking account.

2. Online savings account

After all monthly bills are paid off, any excessive fund will be shifted to high yield online savings banks (here’s how we set our savings on autopilot). Since my use of online banks is very simple, I don’t care too much the extra features. As long as the fund is FDIC insured, the bank supports ACH transfer and pays out nicely, I am willing to use it. There are many online banks now pay 5+% APY for your money. If you are looking for big names, Citibank (4.50% APY), HSBC (5.05% APY), ING Direct (4.50% APY, Affiliate link), GMAC Bank (5.10% APY), and Emigrant Direct (5.05% APY, Affiliate link) are possible choices. Some small players offer higher rates, such as Amtrust Direct ( 5.36% APY), UFB Direct (5.31% APY), and IGoBanking (5.30% APY) with low minimum deposit requirement, and they can also provide excellent customer service.

3. Treasury bills

This is my favorite for short-term investment that generates decent returns. Currently 4-week T-bill pays 4.924% APR, which is equivalent to 5.04% annual yield. However, since interests from T-bill investments are exempted from state and local income taxes, your actually yield will be higher (here’s a formula to calculate your equivalent yield). For example, for NJ residents, I will have to get more than 5.38% APY from a bank to beat the T-bill yield. From what I can see, there two drawbacks of investing in T-bill. First, T-bill rates change every week, so you don’t know in advance what you will get for your next investment (a couple of weeks ago you could earn 5.36% APY). Second, you money will be tied up for four weeks, but I think that’s a small price to pay for a better return (here’s how to invest in T-bills).

Several other bloggers have weighed in on this issue with their own opinions. You can find all the discussions by following this and this link. Ben also provided a nice summary that covers everything you want to know about emergency fund.

To get an idea on how much people think is appropriate for an emergency fund, I just created a new poll, How Much Is Your Emergency Fund?, that you can cast your vote from the right sidebar.

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9 Responses to “Where I Put Our Emergency Money”

  1. Q |  Apr 26, 2007 at 12:49 pm

    I simply don’t keep an emergency fund. If an emergency occurs, I will lean on our Home Equity Line of Credit. Until then, I invest our cash.

    Nevertheless, I am going to send what few readers I have to your site to read this, because I think such a fund is critical for most people.

  2. Moneymonk |  Apr 26, 2007 at 12:42 pm

    Everyone is different, because everyone expenses are different.

    We have a mini emergency fund of $1500 and we have a large fund which is about $10K.

    I view emergencies different, to me an emergency threatens your survival. So our mini fund of $1500 is for refrigerator breaks, water heater or stove needs to be replace or dental expenses or car issues.

    The $10K fund is strictly for job loss. We never touch that account.

    So there are mini emergencies and there are major emergencies. I just separate the 2 and have a different account for each one.

  3. Majic |  Apr 26, 2007 at 4:42 pm

    £100 ($200) Floating round the house for “I need money NOW and the ATM is broken” situations
    £1000 ($2000) emergency fund, instantly accessible checking a/c
    £3000 ($6000) in a quickly accessible (less than one day) high rate of return, tax-free savings fund

    Although all these tend to fluctuate up and down depending on how I feel like structuring any spending / investments.

  4. Sun |  Apr 28, 2007 at 10:56 pm

    Majic: Your scheme is more like ours, I am just curious what kind of tax-free savings fund you have. Is it like tax exempted mutual fund?

    Q: In your case, you will have to pay interests for the money borrowed, right? Besides, normally how long it will take before you can get the money?

  5. majic |  Apr 29, 2007 at 8:02 am

    In the UK, you can set up an cash ISA (individual savings account) which works much like a savings account, but you don’t pay tax on the interest. However, you can only put £3000 a year in, and if you take any money out during the tax year, you lose interest on that.

    These accounts pay something in the region of 5-6% maximum, so although it’s not a great deal it’s better than many accounts. It’s a good solution if you’re not likely to need to dip into the fund regularly, so I would only use it as a last resort.

    You can also get stock & share ISAs, something I’ve not investigated too thoroughly. IIRC it’s much the same deal as a cash ISA but with a limit of £7000 of stocks put in a year.

  6. Q |  Apr 29, 2007 at 7:33 pm

    Hi Sun,

    Yes, if I borrowed money from my Home Equity Line of Credit in case of emergency, I would have to pay interest. The thing is, in 6+ years of marriage, we’ve never had an emergency. I am not a fool to think that an emergency could not occur. It’s just that they don’t occur very often. So I choose not to save up the $10,000 or more dollars in cash that an emergency fund would require. I just personally feel better keeping as much of my money invested in stocks as possible. For those of you that keep emergency funds, it’s a good idea for you, and it sets your mind at ease. This is wonderful! It’s just not for me.

    My Home Equity LIne of Credit is just that – a line of credit that’s always available to me. I have a checkbook that I can write checks out of. So if an emergency comes up, I just write a check.

  7. Tim |  Apr 30, 2007 at 12:08 pm

    e-funds depends on your risk situation. if you are in a risky career field, you might opt to have and boost an e-fund for income disruptions. if you are in a riskier lifestyle, you might opt to have and boost an e-fund for medical/repatriation/etc. if you are in a riskier time for things breaking, you might opt to have and boost an e-fund for repairs and/or replacements. if you are in an area prone to riskier climatic changes, you might opt to have and boost an e-fund seasonally.

    it’s all situationally dependent. moreover, for income disruptions, you will not need the entire e-fund immediately, so est. maturities or liquidity periods allows you to access funds without having everything in cash.

    e-funds are also like insurance, you only need it when you need it. b/c no one has a crystal ball with which to see 20/20 into the future (if you do, let me know), e-fund is a safety precaution. now people might depend on a HELOC, but hey if you need cash now a HELOC takes time and doesn’t work on the weekends or whenever the banks are closed.

  8. brody |  May 09, 2007 at 8:01 pm

    Emergency money should not include anything prone to inflation like paper currencies. You shouldn’t hold cash, because that is the first thing that will be worthless when the economy collapses. Instead, invest in precious metals such as platinum, gold, and silver. These investments do not lose value to inflation, are easy to store/conceal/transport, and will last forever. Their are different ways to invest in gold or silver, but I recommend holding the physical metal, or opening an offshore digital gold currency account.

  9. Ron |  May 30, 2007 at 1:29 pm

    Depending on credit in an emergency should be your last choice. Cash in a protected account must be your first line of defense if something terrible happens. What could happen? A major injury that ultimately causes you to lose your job. It could take months for everything to settle and have any insurance policies in place kick in. It could take many more months before you could obtain other work, if ever. Should something like this happen, how long do you think it will be before your creditors start calling those loans?

    If you don’t have money saved back for this kind of emergency you are hurting your family.

    Ron