Have You Stashed Too Much Money in Your Emergency Fund?

Last year heralded the case for a robust emergency fund. As people lost jobs left and right due to the COVID-19 pandemic, you probably checked and double-checked your emergency fund (I know I did). 

However, have you ever thought about how so much of a good thing can be just that — too much? Your emergency fund could end up way too plump. 

Where People Usually Put Their Emergency Funds

Where do most people stash money in order for it to remain truly accessible? Most people put their funds in one of the following categories:

• High-yield savings accounts: You usually find high-yield savings accounts at online banks, not at brick-and-mortar banking institutions. (They don't have much overhead due to their status as online banks, so they can offer higher returns.) High-yield savings accounts usually earn around 0.50% annual percentage yield (APY). 
• Money market accounts: A money market account, also called a money market deposit account, offers a deposit account that pays you interest based on current interest rates in the money markets. You can find money market accounts at local banks. Money market accounts often come with a debit card and check-writing capabilities.
• Checking or savings accounts: You won't earn much interest with checking or savings accounts at a brick-and-mortar bank. Earnings for both of these types of accounts can range from 0.03% to 0.04%. However, you can access your money at any time, which means that these accounts offer major liquidity. 

Any of these options make sense because you can easily get your money out when you need it. However, if you put too much money into any one of these, you could risk a lack of growth and put yourself at a disadvantage, tax-wise. 

Before you choose the right vehicle for you, check rates, fees and withdrawal rules.

Too Much of a Good Thing Can Be Too Much

Emergency savings offers so many great things — to a point. Let's take a look at the downsides to putting an overly large amount in your emergency fund.

Downside 1: Your money may not grow.

Where do people usually park an emergency fund? 

Somewhere liquid and highly accessible, like a money market account or a high-yield savings account, right? You want to have access to that money the second your boss says, "Sorry, but I have some bad news…"

Here's the deal. Let's say you save $1,000 at 0.01% APY. After a year, you’ll end up with just $1,000.10. If you put the same $1,000 in a retirement account that earns 6%, you would earn $1,062 after a year. See how you could lose out?

Most accounts that offer a safe haven for your money often don't offer ample returns. 

The average stock market return hovers around 7%, three times higher than any high-yield savings account rate offered anywhere today.

Downside 2: You could lose out on the tax front.

When you focus on saving in your emergency fund too much, you may neglect your tax-advantaged retirement accounts, which could include 401(k) plans, IRAs, 457 plans or 403(b) accounts. 

Let's say you have the opportunity to contribute $6,000 into a traditional IRA. Your contributions get deducted from your taxable income. You would only pay taxes on the remaining balance.

Let's say you make $60,000 per year. Your taxable income automatically gets reduced $6,000 to $54,000 from your traditional IRA tax deduction.

What happens when you save your money in a high-yield savings account instead of a tax-advantaged account? You miss out on that reduced taxed income.

Downside 3: You may not clear out your debt.

You may hear so much about the importance of emergency funds that you ignore the fact that you still need to pay off debt. That begs the question: What kind of debt do you have? Credit card debt? Student loan debt? You may want to pay down those debts first and then tackle your emergency fund. Or you can save $1,000 for emergencies to start out and then tackle any outstanding debt.

Downside 4: You may sacrifice other goals.

When you don't contribute to your kids' savings accounts, to your own retirement or maybe even save for a down payment on a house, stop and ask yourself why. 

A gargantuan emergency savings might not mean much when you're stuck putting a vacation on a credit card or forgoing a child's college savings account altogether. 

So… How Much Should Go in Your Emergency Fund?

Obviously, this answer depends on a few factors, including your current income amount. Many financial experts advise saving three to six months' worth of living expenses. 

For example, let's say you generally spend about $4,000 per month on general expenditures, such as your mortgage payment, utilities, food, health care premiums and other items. You should save between $12,000 and $24,000. 

However, you may want to adopt the 3/6/9 rule instead, depending on your job situation. In other words, you may want to: 

• Save three months of expenses if you have a steady paycheck, have no mortgage or dependents.
• Save six months of expenses if you have a steady paycheck, have a mortgage or dependents. 
• Save nine months of expenses if you have irregular income or if you are the only one in your family who earns money. 

How Much Equals Too Much in Your Emergency Fund?

As you can see, it's easy to have too much in your emergency fund. If you find that you've stashed more than six months' worth of emergency money in your account and have a steady paycheck, no mortgage or dependents, ease up.

Carefully consider whether you have too much in your account based on the stability of your income and the number of people depending on you. You may also consider the level of support you receive from others. (Your parents might love it if your family moved in if it came down to it!)

When you do decide on the right amount, automate transfers so they occur each and every week or month. That way, you don't have to think about saving — it just happens.