Your Emergency Fund—Does Size Really Matter?

Emergency funds are as individual as their owners. Consequently, there is no one-size-fits-all. The only critical feature of an emergency fund is that it meets your needs. Most emergency funds are created to deal with job loss or illness. Others might see the role of an emergency fund through the lens of a natural disaster or a geopolitical event. Emergency funds for these events would take on a different character entirely. The focus here is on an emergency fund designed to shepherd you and your family through a temporary loss of income due to job loss, illness or some similar event that interrupts your income stream.

When deciding how large your emergency fund should be, you should consider both your financial obligations and your living expenses.

Financial Obligations

Your first consideration should be the scope of your current financial obligations. This would include mortgage/rent, any installment debt (car payments, etc.), credit card payments, utilities, insurance payments, and all other recurring monthly payment obligations.

Living Expenses

How much are you spending each month on life’s necessities? This should include food, prescription medications, child care, and transportation costs. In short, all expenses you deem essential for day-to-day living.

Don’t Be Tempted

At this point you are probably thinking, “Okay, I add my total monthly payments to my total living expenses, then multiply that by six, and I’m good to go!”

While I will concede that this would be better than pulling an arbitrary number from thin air, I would encourage you to take the process a few steps further and develop a rational plan that optimizes your financial well-being.

For example, an emergency fund designed to sustain you and your family through six months of unemployment may be adequate for certain people, but inadequate for others. As I said, an emergency fund isn’t just a box you check off on a to-do-list. There are a few additional variables that need to be taken into account.

  • A. How stable are your income streams?

  • B. How easy will securing new employment be for you? For your spouse?

  • C. What is your appetite for risk?

The compelling reason to take other factors into account is this: While you want an emergency fund robust enough to meet its purpose, you don’t want to have more funds than necessary tied up in a low yielding savings instrument.

Emergency funds need to be liquid, and by liquid I mean readily available as cash. This means a savings account, a money market account or at the extreme, a short term certificate of deposit. None of these pays you much in the way of interest. As a result, you want to keep the money you have in these types of accounts to a minimum.

A Radical Approach

If you and your significant other are both employed, then plan for the loss of the largest income stream, regardless of the probabilities of losing one over the other. The only safer approach is to plan for the simultaneous loss of both incomes, creating a greater savings burden. The decision is yours.

The duration of an emergency cannot be predicted with certainty, so you will need to allow common sense, good judgment and your appetite for risk to dictate your goal.

Most experts agree that emergency funds should be liquid, and while I concur, I also recognize that tying up significant amounts of capital in highly liquid savings accounts comes at a price–lost return on investment.

In my view, only the first month’s funds need to be in a highly liquid, low return account. The second month’s funds could reasonably be placed in a higher yielding, although less liquid, savings instrument. The third month’s funding could reside in yet another, even less liquid investment, that provides a yield superior to the second month return … and so on!

For Example

Month 1: Savings, money market checking

Month 2: Short-term certificates of deposit

Month 3: Equities, mutual funds, ETFs, etc.

Month 4 and beyond: Largely unrestricted (no real estate)

The rationale for structuring your emergency fund in this manner is fairly obvious. By saving the first month’s funds in highly liquid savings or money market checking, you have achieved two critical objectives: liquidity and ease of access. The second month’s savings are still relatively liquid, but offers you a slighter better rate of return. In the third month, by having your emergency funds invested in equities, mutual funds, and ETFs, you have ample lead time to convert these assets to cash (60 days) while preserving optimal rates of return. After the third month, liquidity is less of a concern and using your usual investment strategy should not represent a concern. Ample time exists to convert these assets to cash should that become necessary.

There is no logical reason to have six months (or more) of your capital tied up in low yielding savings or money market accounts. This strategy is the best approach to an emergency fund because it allows you to preserve access and maximize your return!

What about You?

How have you structured your emergency funds? What are your thoughts on this approach?



  • Yes! Love the “living on one income” route! We do it now by default (Mrs. finishing up PHD) but I cannot WAIT until she picks up a job again because we’re already used to living on the one! So this helps with life changes and goals too, not just emergencies 🙂 If she wanted to quit and raise our kids at home going forward at least we know we could do it.

  • If you are single, try living on half.

  • Emergency fund = critical. I prefer having at least a year. That way, the emergency fund can also become the “I hate my work situation” or the “I want a new career” fund. The peace of mind can help overcome the inertia associated with doing something that is right for you, your family, your sanity. It has helped me make life-changing decisions because I was not shackled by dependence on a fat pay check.

  • Hi, first time reader here; enjoyed the article and will browse some more.

    I like your approach, I’ve been struggling with how much to have ‘liquid’ while I’m building wealth. I have a wife, a home and one daughter – so I tend to lean a bit higher on the liquid (the lowest being 2 months living expenses instead of one).

    In the past, I would have 6-12 months.. but realizing recently that I was missing out on some growth in the equities and mutual fund step you mention.

    Chat soon,


  • H. D. Carver /

    Excellent points that go right to the heart of my one-size-does-not-fit-all statement. Everyone faces unique concerns and challenges. I applaud you for addressing yours. Keep up the great work!

  • H. D. Carver /

    You really can’t put a price on peace of mind. Having some flexibility with your goals certainly gives you more freedom of choice with regard to the future. Yet another positive characteristic of a well planned emergency fund! Thanks for sharing.

  • H. D. Carver /

    That’s a smart move Steve. We can’t afford to be leaving money on the table these days! Thanks for stopping by Your Finances Simplified. We hope you’ll come back often!

  • Samantha /

    I enjoyed this article – it really got me thinking about our Emergency Fund and the reasoning behind it. I’m pretty conservative, I guess. We have two incomes, and our fund would cover us for 3-4 months if we lost both jobs simultaneously.

    I’m really struggling with the idea of moving some of this money out of savings and into equities… even money for months three or four. I think my rationale is that if an actual emergency were to occur in my life (myself or my husband in an accident, say), I would not want to deal with decisions like “In two weeks I’ll need to sell X stock for living expenses next month”. I mean, if he’s in the hospital or whatever, I’ll have enough on my plate without worrying about which CD is which.

    Does that make sense? Am I alone on this?

  • H. D. Carver /

    Samantha, it makes perfect sense … for you! Remember, the principal motivation for establishing an emergency is peace of mind. If you have concerns about moving some of these funds into equities, then don’t do it! Why sacrifice the peace of mind you have struggled to achieve? Others may be very comfortable in doing what I have suggested. It is your peace of mind that is paramount. After all, it is your emergency fund.

  • […] Cash is not a four letter word. While holding cash reserves will cost you income opportunities in good times, when there is a financial crisis, cash is king. If we learned nothing else from 2008, we learned that having a cash reserve is critical to survival. What percentage to hold, in cash or cash equivalents, is up to each individual, but to have no cash reserves is an enormous mistake. Build an emergency fund! […]

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