It’s good to have cash reserves for a rainy day. But read on to see if you’re going overboard.
Image source: Getty Images
You never know when you might lose your job or need to pay for an expensive home or car repair. That’s why it’s so important to have money in a savings account at all times. Without an emergency fund, you might easily land in debt when unexpected expenses or circumstances arise.
As a general rule, it’s a good idea to have enough money in savings to cover three months of essential expenses at a minimum. And some financial experts will tell you to go beyond that point. Dave Ramsey, for example, says to aim for a six-month emergency fund, while Suze Orman recommends socking away enough money to cover 12 months of bills if you can.
But there may come a point when you actually have too much cash in your emergency fund. And while that’s certainly preferable to not having enough, it’s an issue you’ll want to address.
Do you have too much cash in savings?
It’s possible to make the argument that there’s technically no such thing as having too much cash in emergency savings. But one thing you should realize is that the money you keep in the bank will only grow so much based on interest rates. If you put some of your excess savings into the stock market, it has the potential to grow even more.
Right now, savings accounts are paying more generously than they’ve paid in years. And even with that, you’re looking at an interest rate in the 4% or 5% range. The stock market, on the other hand, has had an average annual return of 10% over the past five decades, as measured by the S&P 500.
Here’s what that means for you. Let’s say you keep an extra $10,000 in cash earning 4% per year over the next 10 years. You’ll grow your balance to about $14,800. But if you invest that $10,000 in stocks at a 10% annual return during that same period, you’ll grow your balance to almost $26,000.
That’s why it’s important to make sure your emergency fund doesn’t have too much cash. And one rule of thumb is that unless you work in an extremely niche industry, you’re probably OK to stop at a full year’s worth of expenses.
If you have a job that maybe four or five people in the country have, then sure, save beyond that. If you were to become unemployed, it might conceivably take you a really long time to find a new job.
But if you work in a fairly common industry and don’t have a particularly unique job, then there’s generally no reason to keep more than a year’s worth of bills in savings. This especially holds true if you have skills that can translate across a range of jobs and industries — qualities like good communication skills and so forth.
Are you OK to only save three months’ worth of bills?
The minimum recommendation for emergency savings is generally three months of essential bills. You may be wondering if you need to go beyond that point, and once again, the answer is that it depends.
If you’re part of a dual-income household, you may be okay with a three-month emergency fund, especially if you and your partner work in different industries or for different companies. That’s because the chances of both of you losing your jobs at the same time may be minimal if you do completely different things.
Also, if you’re a salaried employee, you’ll generally be eligible for unemployment benefits in the event of a layoff. And if you know your company has a severance package, then that, too, should give you some comfort in only saving enough to cover three months of bills.
Otherwise, it could be a good idea to aim for six months’ worth of expenses in savings. That way, you’re not tying up too much cash, but you’re giving yourself an extra cushion in the event of a widespread economic downturn or personal crisis that has you out of work for months on end.
These savings accounts are FDIC insured and could earn you 11x your bank
Many people are missing out on guaranteed returns as their money languishes in a big bank savings account earning next to no interest. Our picks of the best online savings accounts can earn you 11x the national average savings account rate. Click here to uncover the best-in-class picks that landed a spot on our shortlist of the best savings accounts for 2023.
We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.
