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How to Invest Your Emergency Fund


Emergency plans are part of life. What to do in case of a fire, where to meet should you get separated at a crowded event, which hospital to go to in the event of a health crisis? These are all questions you should have answers to in the event of an emergency. But what about a financial emergency? Let’s start with the basics:

What constitutes a financial emergency?

A busted refrigerator, a blown car transmission, a new roof… these are not emergencies. Maybe for your perishables, scheduled board meetings, or holiday decor stored in the attic, but these examples are part of life. They are irregular but predictable: you know that they are going to happen. You should have a budget for these irregular expenses or a ‘rainy day fund’ account to cover such inconveniences.  

An emergency is something that happens unexpectedly, an occurrence at any given moment in time that you could not easily predict. Losing your job, a severe accident or health crisis, or having to care for a loved one are emergencies. Any instance in which your ability to earn income for an extended period of time requires prior planning in order to weather the storm. So, how much should you put aside?

How much should I save in my emergency fund? 

A general rule of thumb states that emergency funds should contain at least three to six months of living expenses. What does that even mean? What expenses? Three, four, five, six… ten months? How do you know how many month's worths of funds you should have?

The monthly expenses you should include in your savings are those that are required or non-discretionary spending. Budget items such as your mortgage (or rent), groceries, car payment(s), student loan payments, tuition, taxes, etc. Anything that you can’t just stop or delay paying without serious ramifications is non-discretionary. This fund does not, unfortunately, include your Starbucks lattes.  

Now that you have an idea of how much money you need to live in any given month, how do you determine how many month’s worth to save? Let’s start with three months and use the following calculations to figure out what is best for your situation:

  • If you have a very stable job, subtract 1
  • If you have lots of job opportunities and recruiters are calling you, subtract 1
  • If you have a job tied to the economy (which is often volatile and susceptible to many outside forces), add 1
  • If your income is not steady, i.e. you work in sales or have a variable bonus, add 1
  • If you own your own business or are an entrepreneur, add 15. Just kidding, add 1 more

You get the idea: the more steady your income and the more secure your job, the less you need in emergency funds. On the flip side, more savings are required if your job and income are less in your control. So now, it is just a matter of simple math:

E x M = EFT (monthly expenses X number of months = emergency fund target)

Starting from scratch?

First, don’t get overwhelmed. No one said you had to have your emergency account fully funded by today, or even tomorrow. Perhaps you are young and just getting started, or maybe you finally paid off some debt and are ready to begin saving… taking the first step is as easy as saving the first $20. Go ahead and open a savings account established specifically for your emergency funds and set up an automatic monthly transfer. Saving just $150/month will net you $5k in less than three years.

Trying to balance your emergency savings along with 401k, HSA, 529... STOP THE B🚍S. I recommend focusing on your emergency savings before setting and striving to reach other goals. I’m not saying you should ignore your retirement - especially if your company will match some savings (free money!). My point is that a job loss emergency has the potential to completely derail any savings progress and could come with steep fees should you find yourself in need of cash and don’t have any liquid assets.

Have lots saved but none specifically designated as “Emergency Funds?”

Some people are fortunate enough to have the opposite “problem:” too much cash and no idea how to invest the money. Additionally, it can be challenging to figure out just how much to keep as emergency funds.

The great news is that if you have a significant amount of money saved in checking, savings, and brokerage accounts (easily accessible, non-retirement funds), then you can start investing your emergency fund into a diversified portfolio. Wait, what? Didn’t I say to keep this fund very safe so that it doesn’t go down in value just when you might need to use it?

A well-diversified portfolio of your brokerage, 401k, and IRA might include 10% in cash and 10% in bonds (all depending on your unique situation). If you have $1m across these accounts, that’s a cool $100k in cash. That should be stored in brokerage accounts (non-retirement accounts) for easy access. There’s not necessarily a need for additional funds beyond that $100k for emergencies.

What if the market crashes 30% (think: March 2020) and you want to use that 10% cash to rebalance into stocks while they are on sale? Make sure that you know what your emergency fund should be (see above) and keep that amount or quickly build it back up by saving from your income over the coming months.

What about saving in a Roth IRA or HSA account?

These are both fantastic accounts to utilize. They are very high on my funding list. I highly recommend maximizing saving into these two accounts when possible. But are they a good place for your Emergency Funds?

The Roth IRA is actually a fine place to hold your emergency fund if you only have the choice of saving into a Roth IRA or holding cash in a checking/savings account. If you have done the work above and saved for things you know are going to happen and this is true emergency savings that you expect to never tap, then go ahead and fund your Roth IRA.

In the case that you do have to tap this money for an emergency situation, you can withdraw your contributions tax-free and penalty-free. Hopefully, you never have to withdraw from your Roth IRA because there are limits as to how much you can contribute each year, making it difficult to refund. Consider other options first (all options!) before pulling money out of your Roth IRA.

The HSA is not a good option unless you follow my favorite strategy of saving receipts so that you can reimburse yourself later. If you have saved $5k or $10k of receipts and have that balance in your HSA, then of course you can withdraw that money anytime tax-free and penalty-free (just keep track in case of an audit). The same caveat as above applies: it’s hard to get money into the HSA due to limits, so only pull money out as a last resort.

Final Thoughts

Losing a job, falling ill or suffering a severe accident, or caring for a loved one is stressful enough. We have insurance to cover our medical expenses and most people wouldn’t dream of going without that safeguard. Consider your emergency fund one and the same. Figuring out how to pay your bills is not an additional stressor you need in your life should you find yourself in a precarious situation. Use the formula and start saving today. ‘Worst case scenario’ is that you never need to use the money. It’s still yours. It doesn’t cost you anything, including peace of mind.