Six Months of Cash?
“KEEP AN EMERGENCY fund equal to six months of living expenses,” advise many financial experts. Seem reasonable? It’s a popular rule of thumb. But it’s also a boatload of money to leave sitting in conservative investments, like a money market fund or a savings account, where it’ll likely lose purchasing power after inflation and taxes take their toll.
Could you hold less than six months of living expenses? For many families, the answer is “yes”:
- If your job is secure—think tenured professor or unionized worker—you might hold just three months of living expenses.
- If you have a substantial sum in a regular taxable account that’s earmarked for other purposes, you might hold a smaller emergency fund, knowing you could always raid this other money if you had a large financial emergency.
- If you’ve funded a Roth IRA, you might keep less emergency money. The reason: You can withdraw your regular annual contributions to a Roth IRA at any time for any reason, with no taxes or penalties owed—provided you don’t touch the account’s investment earnings.
- You might keep a smaller emergency fund if you have easy access to borrowed money through, say, a home equity line of credit.
- If you’re retired, you could hold a far smaller emergency reserve—and perhaps none at all. Remember, the big financial emergency is losing your job, something you don’t have to worry about once you’re retired. Moveover, most retirees will already have substantial holdings of conservative investments to cover upcoming living costs, so keeping a separate emergency fund is arguably unnecessary.
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I suggest another bullet point to your excellent list, Jonathan, pensions. My wife and I don’t really have an “emergency fund” because we have defined-benefit pensions that have COLA’s and more than cover our monthly expenses. Excess $ goes to our vacation account, home/auto maintenance account, and a couple others, each of which is a high yield savings account — I guess that makes those accounts our “emergency funds”.
This is some good advice. Unfortunately, too many people get “cookie cutter” advice from cookie cutter advisors, with no imagination.
My personal recommendation includes consideration of your age, because there is ageism running rampant in our beloved country, and people over 50 will experience longer period of unemployment, as they search for new jobs. In my opinion, for over 50 folks, 6-12 months is more likely the “right number.”
As to emergency funds for retirees, that requires a different solution. As the author pointed out, retirees doing not have the primary need for emergency funds that working people have, namely protection from job loss. However retirees do have the issue of “down markets” combined with sequence of returns risk. By holding 12-18 months of cash/cash equivalents in CDs, Money Market Funds, various Treasuries, etc., they will be shielded from having to sell investments to cover living expenses during “down markets.” Now if they have guaranteed income, in the form of Social Security, or pensions, or other investments providing guaranteed streams of income, holding that much cash will not be necessary, but many retirees will opt for it anyway.
I certainly know I have. My “emergency funds” are in a Reverse Mortgage Line of Credit as well as in some CDs and Treasuries, all of which mature within 18 months.
Thanks for the comment. I think it’s important to distinguish between unexpected spending — surprisingly large medical bills, sudden need to replace the car, losing your job — and expected spending, such as the need to cover living costs in retirement. The latter isn’t a financial emergency. Rather, it’s fully expected and should be baked into your retirement portfolio, rather than paid for using a separate emergency fund.
Potential problem with your advice for retirees. Conservative investments are down also, so if one has no emergency fund, they would have to sell for a loss. Even short term bond funds are down. Cash or money markets are not