3–6 Months Savings is Not an Emergency Fund

Dessy John

You need at least 2 years to weather a real crisis

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Whether you are early in your wealth-building journey or on the cusp of retirement, the importance of an emergency fund cannot be understated. If you are early in your journey, common advice is to build up this emergency fund prior to paying down debt or investing. This is to ensure one can cover basic expenses in the event of a job loss or to cover any large unexpected expense such as a big medical bill. If you are in the later years of your journey, then an emergency fund is also critical in order to have a safety net to withdraw from in the event of a market crash. This will allow an investor to avoid selling assets at a loss and instead give them time to recoup their market value.

On both ends of the wealth spectrum, the advice to have an emergency fund is entirely valid. However, the amount in this fund is often recommended to be only 3–6 months of expenses. When we consider the reasons for WHY one would need an emergency fund in the first place, this amount is far too small. Let’s explore this on both ends of the spectrum…

Case A: 3–6 months emergency fund at LOWER wealth levels

The median salary for someone in their 20s in the US is just over $30k per year*, while the median net worth for this bracket is about $9k** (note that the average is far higher at over $90k, but that is heavily skewed by high earning outliers). Further analysis of these and other cohorts are referenced below:

*https://dqydj.com/income-percentile-by-age-calculator/

**https://www.personalcapital.com/blog/investing-markets/average-net-worth-by-age/

A job loss at a lower income threshold is rough in and of itself, but a job loss during a recession is especially devastating as the corresponding unemployment tends to disproportionately impact lower-income earners. Research from the Economic Policy Institute during the Covid-19 economic slowdown showed a considerably disproportionate job loss for service occupations (among the lowest in average wages) compared to sales, support, and management roles.

It is worth noting that Black, Asian, and female groups were also disproportionately impacted during this period. As marginalized groups are already at the lower end of the wealth spectrum, the gap for them appears to widen when macroeconomic conditions are poor. For those in jobs or industries impacted greatly by a recession, it’s hard to expect brighter conditions for their job prospects over a period of 3–6 months. History tells us the market recovers from a bear market in about 15 months on average, but the sectors of the economy driving the bear market are likely to take a bit longer to regain their footing. This is why an emergency fund should extend to 2 years before someone on the lower end of the wealth spectrum should begin investing more aggressively for growth.

Case B: 3–6 months emergency fund at HIGHER wealth levels

As an example of a High Net Worth Individual (HNWI), let’s consider a 50-year-old in the 90th percentile for income, which is about $140k annually. The median net worth for those in their 50s is just under $400k, with the average much higher at over $1.3M (again, skewed by the outliers). Emergency funds for this cohort serve a much different purpose, acting more as an alternate bucket from which to withdraw funds in the event of bear markets. It’s less of an “emergency” use case in that sense and more of a mechanism to protect asset value while covering living costs.

The biggest market scare in recent memory is, of course, the 2008 housing crash and subsequent recession. How would a 3–6 month emergency fund have fared for an affluent individual in this cohort losing their source of income at the onset of this crash?

Historical data tells us that If someone had begun exhausting a 6-month emergency fund in late 2008, fully depleting it in early 2009, their investments in the S&P 500 would have dropped by over 40%. This would have forced them to sell assets at a massive loss if they were unable to secure new income during that period.

One can also point to the fact that full recovery from the pre-recession peak took about 5.5 years. While this is far longer than my recommended 2 year period of savings, the vast majority of the recovery took place from early 2009 to early 2011. If this is the worst case in recent history, it provides a good benchmark to prepare for any future catastrophic events.

Nothing is guaranteed, but past data is the best information we have in insulating us from future risk.

Closing thoughts

It’s tempting to tilt a higher than recommended percentage of your portfolio into growth assets, particularly if you are young. If you are fully confident in the security of your primary income source, this isn’t necessarily a problem. However, if your job security has question marks, or you plan on leaving a stable income source in pursuit of more volatile endeavors like side hustles and entrepreneurship, you may want to lengthen the time horizon for your safer asset allocation.

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.

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I am a personal finance writer, covering advice and strategy around building wealth and living a more abundant life. I have 13 years of marketing experience in the tech industry, have built my own wealth, and now aim to do my part in spreading financial literacy to help others.

San Francisco, CA
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