We've talked about the virtues of having an emergency fund. However, as finance blog The Simple Dollar highlights, money in an emergency fund is money that's not in your investment portfolio. So how much should you keep in it?
The Simple Dollar explains that emergency funds are designed to be liquid assets (money you can access quickly), so they naturally make bad investments. This is OK and, by itself, it's not something to worry about. Determining the portion of your money that should be in an emergency fund gets trickier though:
Right now, our emergency fund makes up only a few percentage points of our net worth. Even when we first started our financial turnaround, we only established a $1,000 emergency fund, which was still only a small fraction of the total value of our assets.
An emergency fund is simply a sacrifice of returns on a small portion of your money so that you have something on hand that's very liquid and very low risk. It's not meant as a major part of your retirement savings or your investment strategy. It's meant as a buffer against things that might happen to you.
How do you determine how much of your cashflow ends up in an emergency fund? Do you use a percentage of your income? A set dollar amount based on your expenses? Or do you go with a flat $1000 or so? Tell us about your strategy in the comments.
Is an Emergency Fund Necessary? [The Simple Dollar]