How Much Should You Have in Savings?
Published on - October 7th, 2009 (Modified on - June 21st, 2010) (by J.D. Roth) 
A couple of weeks ago, we had a fine discussion about how much we should save for retirement. But how much should we have saved for today? How much should we have in cash reserves?
As I write my own book, I’m reading (and re-reading) dozens of other money manuals. While perusing Bert Whitehead’s Why Smart People Do Stupid Things With Money, I came across his table of “minimum base liquidity”. (Whitehead is a highly-educated financial advisor. He uses terms like “minimum base liquidity” instead of “cash on hand”.)
Whitehead writes:
After making the commitment to save 10% of their income, the next question most people ask is, “Where should I be investing these savings?” The first goal is to have adequate cash reserves.
Many financial pundits in the media say everyone should have cash reserves equal to 3 to 6 months of income. For most middle-income people, that is simply a pipe dream…With our clients, I use a different and more realistic approach.
To Whitehead, adequate cash reserves differ depending on your circumstances. His “different and more realistic approach” uses a tiered system:
- If you are an employee with a regular income, you should have 10% of your annual income in a high interest savings account.
- If you are self-employed or your income fluctuates (through commissions, for example), you should have 20% of your annual income in savings.
- If you are retired, you should have 30% of your annual income in savings. (I’m assuming this means retirement income since if you’re retired you don’t have employment income.)
- If you’re in danger of losing your job, you should have 40% of your annual income in savings.
Whitehead draws a distinction between cash reserves and emergency reserves. I’m not exactly clear on what he thinks each is for. I get the impression that the cash reserves — the “minimum base liquidity” — is merely the minimum Whitehead believes we should have on hand to aid in our cash flow. This should also be used for occasions when the car breaks down or the roof leaks.
As insurance against severe emergencies, Whitehead recommends maintaining “emergency liquidity” equal to twice your cash reserves. (He also says to hold this money in retirement accounts, not savings accounts.)
Though I find certain elements of Whitehead’s plan confusing, I do like his tiered approach to saving. It makes sense to me that not everyone should save the same amount. Our circumstances and needs are different. As always, do what works for you.
For more information, borrow Why Smart People Do Stupid Things With Money from your public library.
This article is about Ask the Readers, Basics, Savings
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@Oisbroke
I think maybe your financial situation is sapping your energy to improve your overall situation, which becomes a cycle. Think about whether there is anything BIG you can do to break the cycle. For me it was joining the military but there are other options out there. Peace Corps? Something where your living expenses are pretty much covered. One of those farms where they provide food / housing while you work? If you have a family you have to provide for of course that will effect what your options are but maybe there is something out there that lights a spark for you. It’s not a permanent solution but it may be enough to clear up your mind to find the next thing. I guess you don’t really need to move to a commune to do this but the main thing is to find something that recharges you. Trying to change the trajectory of your life while you are coming from a place of debt and low energy is extremely difficult to do!
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I agree with all the people who questioned the 6month or 10% rules, etc.
Although it’s kinda how I’ve done it. Laddering six 6-month CD’s has been my solution to unexpected loss of income.
Maybe this is just me, but unexpected expenses do not scare me that much. I rent. I bought my car outright (1995 Ford Escort with 44k miles in great shape, for $1800), and am comfortable working on it myself for maintenance. (Great car by the way, for anyone looking, why buy new or even newer? I average 28mpg!).
With 6 months of income saved, and a line of credit with a low interest rate I don’t feel saving more money is worth it. I’d rather see it in my roth or 401. Plus, I can always find a credit card with 6 months of 0% interest for something unexpected.
For me, there is a limit to how many “lines of defense” I feel are necessary to protect myself from the unexpected.
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@100 – I work hard so my money doesn’t have to. I enjoy knowing that even if I don’t get the average 8% ROI every year, I can still retire comfortably.
And six figures is not years’ worth of income for everyone. For some, it’s only one year.
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I find it odd that he only recommends 10% of your income starting out. For someone making $30,000 (post-tax) per year that is only $3,000. That’s a little over 1 month’s worth of income which I think is drastically low.
People don’t save 3-6 months of expenses because they get it in their heads that they can’t. If they would plan for it and chip away at it I think they would find it isn’t as far off as they once thought.
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I’m not the silly boy Tim from #22.
I think people forget the purpose behind an emergency fund, investment fund, retirement fund, day at the spa fund, etc. they are for different purposes. emergency funds are for emergencies to have liquid cash when you need it in the amount you need it. it is your first line defense against having to take a beating on opportunity costs, taxes, penalties, and fees of cashing out stocks, bonds, IRAs, 401ks, taking out loans, etc. it’s part of your wider diversification, too.
emergency fund is not an investment, it isn’t for retirement, it isn’t for the spa day (unless it really is an emergency ;o)), etc.
emergency fund rules of thumbs are just that, suggestions. people ought to flex according to their individual situations. some folks are in riskier occupations, in occupations that take longer to find another job, some folks are accident prone, some folks live riskier life styles, etc.
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@ No Debt Plan #104
That is quite odd. For us, 10% would work out to about two months of core expenses. He’s set the bar quite low.
What is even more odd is his idea that “Emergency liquidity” of twice your cash reserves should be in retirement accounts! If you do that, then it is no longer for emergencies (it would be for retirement), nor is it liquid (hello, taxes and penalties!).
Bert’s advice just comes off borderline bizarre and really makes me question what it is that these groups saw in him to rate him in the top whatever of financial planners. Apparently I’ve missed it.
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@105 Of course an emergency fund is an investment. Simply because it is an investment where one purpose is to guarantee financial safety doesn’t mean that people should ignore the opportunity costs involved. I think too many people don’t have a grasp on just how much money they are losing by plopping large quantities of money in cash and cds. Take Jonathan over at mymoneyblog, he’s had like 100K in cash for the last couple of months; that’s literally like $40,000 in money he’s missed out on over the last couple of months because he didn’t consider this significant portion of his networth to be an “investment.” I don’t understand the people who seem to be content to lose out on this return, its like they don’t want more money. Bizarre.
People don’t seem to have a grasp on the fact that in most cases, the most likely emergency would not involve dipping into anything more than a few months worth of emergency fund. Anything beyond that might be good to have saved away in case of a cataclysmic emergency, but it isn’t likely to be used. Therefore, it should be invested in longer term assets earning a better return. Sure those assets are riskier, but over the long term such risk is reduced especially if one is properly diversified.
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Shame on Bert for not coming up with a book title of his own.
Why Smart People Do Stupid Things with Money: Overcoming Financial Dysfunction
sounds suspiciously like the title of the much better book
Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics
http://www.amazon.com/Smart-People-Money-Mistakes-Correct/dp/0684859386/
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@Alex (107) – No my view is the Emergency Fund (EF) is insurance. I am self insuring my family against events not covered by insurance.
I have life, health, auto, home, disability and umbrella insurance. All those premium payments I pay I’m sure invested I would be rich if no calamatiy hit me or my family.
No I dont view the EF as an investment but insurance. Alex does make a point if you list the EF as an asset how do you quantify the liability of an unknown event? Do you count your EF in your net worth?
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@109 – Gholmes
Very well put.
It is of course very tempting to take such a large chunk of money and try to ‘get some return’ on it while it’s sitting there. But the purpose of that money is not to get returns. The job of the EF is to be there when you need it – all of it.
When calamity does strike, you shouldn’t be worried about if the money is there. As we’ve seen, stocks do lose money sometimes. CDs and other financial products can have early withdraw penalties.
A simple money market account is about as about all the investment your EF needs. You can include it in your net worth if you want (it is cash after all), but for the most part, we park it and forget about it.
That investment knife cuts both ways, btw. We had a large chunk of money inadvertently not invested for two years. Those years just happened to be 2007 and 2008. That’s 40% that we didn’t lose.
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@109/110- I guess the differences between us are that
a) I feel the most likely emergency would only require one or two months worth of expenses
b) a cataclysmic emergency is less likely and therefore from a probabilities perspective, the expected time I have before I would need more than two months worth of expenses would be several years, if ever.
c) In those several years, I am overwhelmingly confident my diversified portfolio can beat the 1.5% interest rate on CDs or cash.
d) even if I am wrong about b or c, I will still have enough money to cover the cataclysmic emergency, because I have saved extra money to cover such a scenario.
e) If no cataclysmic emergency occurs, jolly. I now have an early retirement fund.
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I have about 13 months of income (which is around 3 years worth of living expenses) in savings accounts. That is mostly in an emergency fund although some of it is earmarked as vacation money (no specific vacation in mind) or car replacement money (I am aiming for another 3 or so years on the current car). I max out my retirement options (401k/403b and Roth IRA) each year. And I have another, ~40% of my annual income in non-retirement investments (obviously this amount fluctuates with the stock market).
Could I do this straight out of college? No. But it *was* possible even given that I have only been out of college for 11 years, and was unemployed for slightly more than one of them. How? I spent like a poor college student even after I had a job. I did not have a car until after I had had a job for a year (biked to work). I shared apartments rather than renting a one bedroom place for myself until 4 years ago.
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@Alex #111 –
It’s not so much that I don’t see those scenarios as plausible – it’s just that I’m not willing to take those risks. I’m not willing to play the odds.
Our EF is piece of mind.
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@Alex, and if he had an emergency that required $100k and invested in what the stock market when it was tanking, he would not have $100k. Investment implies wealth accumulation rather than capital preservation. Emergency fund needs to be preserved and liquid, because it isn’t you are risking the chance of not having enough money to cover your emergency. If you do not, then you may be forced to liquidate assets that are for difference purposes and which carry a high cost to liquidate. of course if something happens that requires significant amounts, all bets are off and you will have to resort to liquidating even hard assets. The intent is not to have to take such a loss. for example, someone mentioned taking out principle of roth ira in an emergency. you do that as a first line funding source, then you completely lose out on the benefit of the roth for retirement as well as not being able to replenish what you took out. investments also imply a greater deal or risk, and that is not what you want to be doing with an emergency fund.
this does not mean that you cannot store it somewhere that affords you the ability to preserve capital and withdraw as needed without penalty and within the time span of the need.
As I mentioned before, everyone’s situation is different. If your assessment is that you have a very low risk of income disruption, then you might not require as extensive of an emergency fund as someone else. However, if you are in an esoteric career field or a saturated career field makes finding a new job difficult, you might assess needing more to fund income disruption.
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I think 5K or the same as your credit card limit is a good emergency fund (ER). I keep that money in a security box at my bank. I am not worried about investing that money.
We started saving 10 % of our 65k after tax yearly income. We started buying stocks and bonds but it did not work out because as soon as we had an extra expense we to sell them . That was when I realized we needed to have a savings account with a minimum of 5 K.
The past 10 years I been documenting all our income money , expenses, savings and investments as well as our debt in a book keeping notebook.
I have used most of our extra money to pay off bad debt (credit cards)
and I have gotten rid of all of them except one and we pay our gas with cash as well but we keep on gas credit card as a back up.
We currently save close to 35 % of our passive income.
My goal is to be absolutely debt free in three years. My 2004 Mercury Monterey minivan has 81 K miles and it is in pretty good shape and is fully paid for. I bought it for 6K three years ago with a credit card. That’s like 30 % below market value. I have no plans to buy another minivan for at least two years and it won’t cost more than 13 K.
So our plan is to pay off our home loans first and then I will pay off in full my student loan.
We carry zero credit card debt. I use the credit card to pay for pre -planned purchases only. I pay the card fully. If I can’t, I won’t buy it.
If I need to use our emergency fund, I will replace the money spent and use the rest to pay off ,as much debt as possible.
We should be fully out of debt in three years from now.
The foundation of a successful life is having a savings account. This money is not intended for expenditures. This money is intended for emergency expenses and should be replaced ASAP.
The question of how much money should one have inn our savings is an excellent one.
If you grasped my method you will be very happy. It takes discipline but it’s sure worth the effort and all the work.
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