Emergency Fund – Do you Really Need One in 2024?
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If you are interested in personal finance, you probably have encountered the concept of emergency funds. An emergency fund is simply some money available directly that you can use for emergencies. Most people will advise you to get such an account. And they will insist heavily on this subject.
It is an interesting subject since not everybody agrees on the importance of the emergency fund. Some people have an emergency fund that can cover one year of expenses. And some people think you do not need one.
An emergency fund is a good thing. But you should be aware of its cost. It also has disadvantages. And you may not need an emergency fund as big as some people tell you. Too many people put too much emphasis on their emergency funds.
In this article, we see both sides of the story. We see in detail what an emergency fund is and whether you should have one.
Emergency Funds
An emergency fund is a bank account where you store some money you may need for emergencies.
A general rule of thumb is to store three to six months of your expenses. But some people will save away more than one year of expense. We will explore below how much you should have in your emergency fund.
It is important to base your emergency fund on your expenses and not on your income. You are not spending your income! Or at least, you should not!
Reasons for having an emergency fund
Why should you have an emergency fund? In an emergency, you have money available to pay for it.
Here are a few examples:
- Imagine you have a huge medical bill coming (2500 CHF), can you pay it?
- Or if your car breaks down and you have to replace it.
- Your house is flooded, and you have to pay a large bill.
- Your phone breaks, and you have to replace it.
Many more reasons make people want to have an emergency fund.
Being able to pay for emergencies is the first level of personal finance. This should be your priority. But these funds have a high cost. And most people do not consider this cost when they advise an emergency fund. We will cover this fund in this article as well.
Where should you keep your emergency fund?
You should have your emergency fund in a very liquid account.
It does not make sense to invest your emergency fund in highly liquid stocks. If you need the money today, you may have to sell at a terrible price. It should be in a savings bank account.
Ideally, you want to save the money in a high-interest bank account. However, sometimes this is not possible. For instance, some bank accounts have limitations regarding when you can withdraw the money. You want this money to be available instantly.
And in some countries, bank accounts have no interest rates, like in Switzerland these last years. In this case, you can keep it in your salary bank account. This makes it very easy. This is what we are doing.
If you feel like you need a separate bank account, feel free to separate it. Just ensure you are not paying any fees to store your emergency money!
Some people save their emergency fund in a money-market account. If you have a good account like this available, it may be a good option. They generally have higher yields. But you need to make sure you can withdraw the money easily and for free.
If you want a free bank account for your emergency fund, read my article about the best banks in Switzerland.
The cost of an emergency fund
Most people never consider the downsides of an emergency fund. There are several disadvantages to having an emergency fund. You must balance these disadvantages to know how big of a fund you need.
The opportunity cost
Emergency Funds have one big problem: The opportunity cost.
The simple fact of not investing this money costs you. Opportunity costs are something that many people never consider. But it is an essential concept.
Instead of having this money in a savings account, you could invest it in an ETF that would give you an average of 5% per year (and I am conservative). So you are losing out on these returns.
We can take my current emergency fund of 15000 CHF as an example. Investing it in the stock market could yield 750 CHF per year. This is a lot! And this is not taking into account compounding interest over the years.
You need to be aware of this. If you have access to high yielding interest account, it may be acceptable. But we do not have anything like this in Switzerland.
If your savings account yields less than inflation, you are losing money every year. In most countries, saving accounts have lower interest rates than inflation. This is almost always the case.
If you want an emergency fund, there is nothing you can do about this cost. But maybe you do not need one. Or maybe you need a smaller one than you think?
The distraction factor
Many do not realize that having a large emergency fund will distract you from your other financial goals.
If you set yourself to save one year of expenses for emergencies, you will need quite some time to do it. For most people, this will probably take a few years. This means that during this time, you will have no money to work on your other goals.
Having a smaller fund would let you work on your other goals as well. For instance, this could let you reduce your debts. Or you could save money towards a down payment on a house.
The temptation factor
There is another cost related to emergency funds: The Temptation.
Some people may be tempted to use the money in their emergency accounts. This should not happen to frugal and responsible people. But this is something that may happen. You may think it is a good place to take money for that brand-new TV you wanted!
If you start taking money out of this fund without an emergency, it becomes useless. You may well not have money on it when you need it!
Do you need an emergency fund?
You may not need an emergency fund as much as you think. Or at least, you may not need it to be as big as you think. There are a lot of people living very well without one. It is a myth that everybody needs a large emergency fund.
Of course, not having an emergency will not prevent you from having to pay for an emergency if it happens. So, how to pay if there is an emergency and you do not have enough in your emergency fund?
- With your credit card.
- Use your next paycheck to pay it.
- Get a margin loan.
- Sell some equities.
If you have a large limit on your credit card, you can pay many emergency bills with it. Or withdraw money to pay for them. If you are saving a large percentage of your income, you have a large part of your salary to pay for emergencies each month. That just means you will invest less the following month.
If this is enough, you have two more options. The first is to get a margin loan from your broker, based on your investment portfolio, if you have any. And then, the worst option is to sell your equities and get cash to pay for your emergencies.
And a lot of risks are not as great as you think:
- If you have health insurance, you only have to pay the deductible and retention fee. This is 3200 CHF for me.
- If you have car insurance, you only have to pay the deductible. This is 1000 CHF for me at maximum.
- If you get fired or do not find a new job after the current one, you should receive unemployment benefits for several months. And unless you did something wrong, you will get a severance package if you get fired.
- If I die, I have life insurance with which my wife can live for several years.
- Lots of things can be planned. For instance, it is not very difficult to estimate when you need new tires. This is something you can budget for. You should try to plan for big expenses. For a lot of people, emergencies could be avoided with better budgeting.
As you can see, you are already protected from substantial unexpected expenses. If you have a stable income, a good credit card, and you save a large part of your income, you can have a small emergency fund. Or even no emergency fund at all.
Of course, if you have no insurance for anything, this may not be the same issue. You need to study the risks you are not protected against.
Saying that everybody needs three to six months of expenses in cash is just dumb.
Of course, this will highly depend on your situation. Some people have more risks than others to lose their jobs. And this can also depend from one country to another. This is why you need to assess your own situation.
Moreover, if you know you are not good at managing money and keeping on budget, you should probably have an emergency fund. But once again, this will depend on each situation.
Emergency funds in retirement
In retirement, things will be very different.
Following the 4% withdrawal rule (or any other withdrawal rate) from The Trinty Study, you live from your withdrawals. You have two choices for this: monthly withdrawals or yearly withdrawals.
Generally, monthly withdrawals are a bit better in the long term. But yearly withdrawals are easier to manage.
If you opt for monthly withdrawals, you will only have one month of expenses in cash ready to be used. In that case, you may want to use a second account for your emergencies.
With yearly withdrawals, you do not need an emergency fund. You already have one year of expenses in a cash account. If there is an emergency, this will mean that you will have to sell shares earlier than intended.
Our emergency fund strategy
We will now talk about The Poor Swiss emergency fund.
We keep an emergency fund of 10’000 CHF. This is a bit less than two months of expenses. This is more than enough for us. I am currently keeping it in my Neon account in Spaces to get some interest in it.
We can save up to 50% of our income each month. That means one salary covers the expenses of two months. We can also cover about two months of expenses with our credit card.
Finally, we have an extensive stock portfolio. Therefore, we could get a good margin loan from Interactive Brokers if we had to pay for an emergency, without selling stocks.
So, we decided to keep 10’000 CHF for emergencies. I am comfortable with that amount for Mrs. The Poor Swiss and me.
Advocates of small emergency funds
Of course, you should not only take my word for it.
Many people in the personal finance community are advocates of small emergency funds. There are even some people who think that they are not useful.
For instance, Big ERN at earlyretirement.now has an emergency fund of 0$ and gives you 10 reasons why they are not good.
Go Curry Cracker also mentioned that Emergency Funds are overrated. If you have a strong financial status, you may not need an emergency fund as strongly as you think.
Another advocate of a smaller emergency fund is Mr. Money Mustache (Pete Adeney).
FAQ
What is an emergency fund?
An emergency fund is an amount of money that you keep ready to pay for emergencies. It should be accessible very quickly, probably in a savings account.
How much should be in an emergency fund?
How much you need in an emergency fund depends on your spending. A rule of thumb is to save between three and six months of monthly expenses in your emergency fund. But, it will also depend on how safe your job is and your risk aversion level.
Should everyone have an emergency fund?
Not necessarily. People who have a stable job and have access to a good credit line do not need an emergency fund. And most people do not need an emergency fund as big as people believe.
Conclusion
Emergency funds are a good tool to protect you against big emergency expenses. However, they have a high cost because that money is sleeping without bringing any interest. Generally, bank account interest is lower than inflation. So your emergency money is losing value every year. Moreover, you are generally more protected against big expenses than you think.
In my opinion, you should not have too big of an emergency fund. If you have an income, having eight months of expenses saved is not necessary at all. If you can save much of your salary, you are already covered for some big expenses. And, of course, you need savings! Nobody advises you to have zero savings. But you should invest most of your savings.
Everybody should have a small emergency fund of at least one month of expenses. But having more may not be as necessary as other people would tell you. And having a huge reserve harms your finances.
If your financial situation is bad, the first thing you need to do is to get out of high-interest debt. Then, you need to increase your savings rate as much as possible. The emergency fund will only come after this. And once you start saving more money, it will come naturally.
Now, as always, it is important to find the solution that works for you. If you cannot sleep without six months of expenses in your bank account, just do it, and do not let anybody tell you it is bad! And if you can sleep with zero emergency funds, do the same!
To learn about another kind of fund, you can read my article about the opportunity fund.
Do you have an emergency fund? How many months of expenses do you keep into it?
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What about having all invested in liquid assets (shares and ETFS) and use margin loan in case of emergency?
That’s a definite possibility.
If you have very few emergencies, this could be worth it. The opportunity cost of non-invested cash is higher than simple margin loans.
Now, is it worth it? It depends on the size of your emergency fund I would say. If you have a large emergency fund (but people willing to do that probably won’t), it may be worth since the opportunity cost may be large.
But with a small emergency fund, I do not think this is worth it.
I would not do it unless the cost of the margin loan was at least two times lower than the opportunity cost.
One disadvantage would be that you will likely need one day to get the money out from a margin loan.
I maintain a reserve fund equal to three years of daily expenses, as I manage my portfolio full time, and that’s the only source of income. Should the market crash down hard and stay down for a year or two, with big dividend cuts, I would need an alternative source of funds to avoid selling shares at the bottom.
Hi,
It makes sense to have a larger emergency fund in retirement, although it’s not really an emergency fund but more a living expenses fund.
For me, three years would be too long, but if you have already enough in your portfolio to sustain your expenses, you are probably fine :)
Congratulations on living from your portfolio.
I’m a firm believer in having a big emergency buffer but in my experience six months is far from adequate. Also, for me an emergency fund is a protection against loss of income and this is very important for anyone working freelance.
In the early noughties there was a severe downturn and freelance IT contracts dried up in London. I was unemployed for quite a few years and had to remortgage to survive as my safety buffer ran out. Fortunately I had made overpayments into my mortgage and my mortgage provider allowed me to borrow against my property.
In the UK, the most I could get in unemployment back then was around £50/week for a maximum of six months and this was because I had equity investments in the form of PEP’s (now called ISA’s). I also took this opportunity to follow a postgraduate in software engineering correspondence course with the Open University mainly to see whether I was still able to pass exams. I knew that this would not help me in getting my next contract and this qualification takes just one line on page three of my CV. In 2004 I took on my very first contract in Zurich with an American bank and well within 6 months I paid off what I had borrowed against my property.
The main lessons I learned from this experience is not to depend on anyone, especially the state, for benefits etc if you fall on hard times. The most I can get in UK unemployment benefit in 2020 is around £75/week regardless of how much I’ve made in contributions and this is because I have savings in the form of equity ISA’s. Needless to say I always minimise my taxes to the maximum but now we have something called IR35 but lets not go there….
I still work freelance and a firm believer in having a big buffer to fall back on and that this buffer should be adequate for at least three years to cover ALL your outgoings. Most of my friends who are long term IT contractors also follow similar rules.
Hi,
I also believe that you should take these kinds of things into account. It is important to consider your unemployment risk. In Switzerland, we can get unemployment benefits for up to two years. This is much better than in UK apparently. This makes sense that the emergency fund should be lower.
In the end, it’s always a personal decision. Some people will always need a larger emergency fund than others.
And this is even truer for self-employed people because they will have fewer benefits in case they are in financial trouble.
Thanks for sharing your story!
Don’t think that money as an Emergency Fund. Think of it as your “cash position”, usable not only for Unexpected Events, but for swooping in and buying depressed securities (hopefully) at the bottom of a bear market.
In my case, a 12 month E-Fund is only 8% of my portfolio. Just as importantly, the 2% I get on fixed deposits in the US is essentially the same as the 2.1% US inflation rate. Thus, I’m not losing money, either.
Hi Ron,
What you are suggesting is known as an Opportunity Fund :)
This could be a good reason to keep some cash!
But for me, these are two very different concepts. You could keep your opportunity fund in your broker account (ready for investing) but it would not make a lot of sense to have your emergency fund in your broker account.
Thanks for stopping by
Hy
Good Topic. Good review. I think the emergency fund is very idiosyncratic. Someone who lives alone in rent and has a saving rate of 50% may not Need a big emergency fund. A Family who lives in an own house (you have to do renovations and buy household articles) and has a very low saving rate may Need a bigger emergency fund. Maybe there is also differences between countries. In Switzerland you have a good social System. I dont know other countries but I can imagine that not in all countries exist good healthcare, unemployment and other insurances.
What an Advantage of building an emergency fund is that it should motivate People with bad spending behaviours. For them it is often the first step how to learn spend less and save more. So for them it could be a good Goal to save an amount of 3 month spendings. Then when they become more Aware maybe they can reduce the amount of the fund.
I was also a messy spender and built up an emergency fund of 3 month spending. But I never needed it because when something happened I saved less. So after 2 years I decided to reduce this amount to 1 month, and after another year I dont have an emergency fund.
I agree, in Switzerland you are good insured in case of bad luck and in case you are not a messy spender there is no Need for a bigger emergency fund than 1-3 month expenses.
Maybe other People with less spending awarenes in other countries could Need a bigger emergency fund.
Hi KM,
That’s a good point! Your need for an emergency fund will also be related to your savings rate. If you are able to save 5000 CHF per month, you have 5000 CHF ready for an emergency in 30 days.
And as you said, and as mentioned in the article, it will highly depend on what you are covered for in your country.
It was already mentioned in the comments that people with bad spending habits will need a larger emergency fund that people that carefully watch their expenses. Once they get their expenses in order, they can start reducing it, as you dit!
Congratulations on having no emergency fund!
Thanks for sharing!
Maybe a bit off topic but how do you save for a downpayment if you know you want to make use of it in the next 2-5 years?
Can’t really invest in stock cuz who knows where they are at by then… would you just keep it on your bank account or invest it somehow?
Thanks a lot
Great article as always – makes me realize that I don’t need too much in my emergency fund.
Hi Peter Pan,
Actually, I think it depends if it’s two or five years.
If it’s in the next 2 years, I would keep it in cash. I would maybe invest some in P2P Lending, but definitely not a lot.
If it’s in the next 5 years, I would still invest in the stock market. In between 2 and 5 years, I do not really know honestly.
Thanks for stopping by!
We have never had an emergency fund but we always had access to more credit than we used. We kept a home equity line as our emergency fund, and since you pay interest on everything you used, there was a built-in check and balance to the temptation of just using it. At the same time, it was more money than we would want to keep in a zero-interest account so it served well as an emergency stash.
Hi Caroline,
Yes, a large credit can help a lot in case of an emergency. A line of credit on the house can be an option to have a large emergency fund.
Did you have to use your emergency line of credit?
Thanks for stopping by!
Thanks for sharing your view and gave concrete numbers regarding the size of your emergency fund. I think 10k for 2 people who are frugal and can manage their cash flow well is more than sufficient. Plus Switzerland is a country with lots of protection like the unemployment and severance benefits that you’ve mentioned.
I do want to add that having 3-6 months of emergency fund is generally not a bad idea for Americans who generally:
– have a low saving rate (5% average)
– can’t handle their money well (I.e. love to spend $$$ due to the prevalent consumerism culture)
– have kids and depending on how many
– have health issues
The last one could be the biggest unexpected expenses.
Hi Mama Bear,
Yes, I think we are pretty safe with our situation :)
However, I completely agree with you that if you are in a bad financial situation, having a larger one could be very good.
The problem is that some people hide behind their emergency funds and do nothing else with their finances. It’s a great first step. But it’s not enough to really have a good situation (out of debt, good savings rate, …).
But it’s also a good point that people with bad health and bad insurance coverage should have higher emergency funds.
Thanks a lot for stopping by!
So wise.
I recently had cataract surgery and my insurance didn’t cover the Type of procedure I needed.
It wasn’t technically an Emergency but my vision had suddenly started getting worse.
So, small price to pay in that sense.
One of my worst fears has always been losing my sight.
So, the grand total out of pocket was about three thousand.
On top of the almost TEN thousand we pay in premiums every year.
I try not to think about it too much, it’ll make you crazy lol
Victoria
Hi Victoria,
It is an excellent example, thanks for sharing!
It may not be directly an emergency fund but unless you save a lot of money each month, this will need to be covered by your emergency fund. I think it’s a good example.
And it’s really sad that it’s not covered by insurance. Losing sight should definitely be covered…
As you said, it’s crazy. We paid thousands each year in premium and then we still have to pay thousands in deductible and some things are still not covered.
All that because a lot of people are using their insurance for small things.
I try not to think either too much about it.
Thanks a lot for stopping by!
If you have a family with kids, you might need to increase your emergency fund. We wrote once a blogpost about the size of an emergency fund dependent on your family situation. With your savings rate, there is no need for a big fund, I agree. With 3 teenagers kids our emergency fund is more than 1 year now to cover our expenses.
I completely agree! It’s highly depending on each person’s situation. It needs to be reconsidered based on the possible emergencies. If you have several teenager kids, you should have more of an emergency fund. And it also depends on the income and on the savings rate. I would still think that 12 months is a bit too much though, no ?
Thanks for stopping by
“1 year now to cover our expenses.” The purpose of an emergnecy fund is NOT to cover your expected expenses, but unexpected ones.
Hi Zoltan
I also agree that you should not want to cover your expenses with it. However, your running expenses are more easy to compute than your unexpected expenses. Moreover, loss of job will have a cost directly related to your running expenses.
Thanks for stopping by