Keep Only What You Truly Need

How much cash should you keep for emergencies … and how should you store it? This question came to light early this fall in a number of financial publications after federal bribery charges against a US senator revealed FBI agents found over $480,000 in cash—plus over $100,000 worth of gold bars—in the senator’s home. Too much, the coverage agreed! And not nearly secure enough! What is a better approach? Let us discuss.

There are two types of emergency funds—money socked away in your home to deal with a natural disaster or other physical emergency that could knock out power and payment networks, and savings set aside for potential unemployment, accidents and major home repairs. The first was the subject of a good Wall Street Journal piece late last month, which found financial professionals were divided on the ideal amount.^[i] Some said $200. Others said at least two weeks’ worth of expenses. One suggested over two weeks’ worth of emergency hotel accommodations and food. Another, who works with people in hurricane-prone Florida, suggested four weeks for people who live in areas at higher risk of floods, wildfires, blizzards, earthquakes and other disasters that could take power (and, hence, ATMs and credit card networks) offline for several days or more. The right course for you likely depends on your vulnerability to natural disasters, family size, local hotel rates and your stockpiles of emergency food and supplies.

There was more agreement on how to store this physical cash.^[ii] If you are trying to ensure you and your family can get through a wildfire or flood, you don’t want said fire or flood to destroy the money—so it is generally not a good idea to store the whole pile in the desk drawer, sofa cushions, hollow books, false-bottomed vases or whatever other clever gizmos you may find. Dividing the money between several locations might seem wise, to reduce the chances thieves make off with everything, but that also raises the risk you or your family don’t remember where it is in the heat of the moment (or when you are decluttering and taking unused tchotchkes to the charity shop). So, boring as it might sound, a good old-fashioned fire safe is likely the wisest choice.

While keeping a physical emergency cash stash is beneficial, there is a big tradeoff: Paper money doesn’t generate interest. Enter the second kind of emergency fund: a larger pool designed to help get you through unexpected tough times. That includes job loss, medical emergencies, car accidents, big-ticket home repairs and the like—anything that could hit you with an unforeseen four- or five-figure bill. (Or maybe a little more, depending on your personal situation and expenses.)

This isn’t just a concern for the many Americans who have little or no savings. It is also important for higher net-worth folks to think about. Let us consider a hypothetical Jim. Hypothetical Jim has $650,000 spread between his IRA, 401(k) and brokerage account, and he is feeling pretty set. Until, that is, an old, rotting tree he neglected too long comes crashing down on his house. Thankfully, Hypothetical Jim and his theoretical family are fine. But the house isn’t. It needs a new roof as well as structural repairs in the damaged rooms, and insurance isn’t covering all of it (he should have taken care of the tree years ago, they say). “Oh well,” says Hypo Jim, “I can just sell some stocks to cover it.” So he logs in to his brokerage account … and then curses an almighty storm because the market is down and he will have to sell at the worst possible time. “If only I had kept a cash reserve in money market funds,” he laments!

This is the main benefit of an emergency fund: It reduces the risk of having to get liquid in a pinch, especially during down markets. Keeping it in cash-equivalent securities may lack stocks’ return potential, but an emergency fund’s purpose requires liquidity and stability. You will want to be able to access it on demand without having to sell assets or endure a complex and costly surrender process. This means CDs generally aren’t an optimal choice for an emergency fund. Better are money market funds, savings accounts or other cash-like securities (e.g., ultra short-term Treasurys).

As for how big your emergency fund should be, this too depends on your specific circumstances. About six months’ worth of expenses is generally a good starting place, but note that this will require an honest audit and accounting of your spending. Tally up all your essential spending (shelter, food, medicine, transportation) as well as nonessential, be realistic about what you can and can’t cut during lean times, and then figure out the number that is right for you. If you have to dip into this for an unexpected big-ticket expense, set a gameplan for replenishing it as soon as reasonable.

Budgeting isn’t the most fun activity on the planet (at least not for most people). But it is one of the most helpful. And what better time than now, as autumn is ramping up, days are growing shorter and cozy nights in are the norm for many? A few minutes spent on tallying expenses and allocating an emergency fund now can save you a lot of time and stress when you are least equipped to take it on.