Can you save too much for a rainy day?
Edward Jones - Chad Choate, AAMS
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Mar 07, 2024
Florida - Sarasota, Bradenton & Charlotte Counties
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“Save
for a rainy day” is an old piece of advice — and a good one. But is it possible
to save too much?
To
begin with, what defines a “rainy day” in terms of financial needs? It could be
any number of things: a temporary loss of employment, a major home or car
repair, a large medical bill, and so on.
If
you did not have the money readily available to pay for these types of
expenses, you might be forced to dip into your IRA, 401(k) or other retirement
accounts, incurring taxes and possible penalties, as well as lowering the amount
of money you’d have available for retirement. And that’s why it’s a good idea
to build an emergency fund containing up to six months’ worth of total expenses,
with the money kept in a liquid, low-risk account that’s separate from the
accounts you use for your daily spending needs.
An
emergency fund is valuable, but many people may be overfunding it. And while
this isn’t the biggest financial mistake one can make, it could result in some
missed opportunities.
For
one thing, when you keep money in a low-risk account, you can generally count
on your principal being protected, which means the money will be there for you
when you need it —but the flip side is that this money likely won’t grow very
much, if at all. And if you’re going to achieve your long-term goals, such as a
comfortable retirement, you need your investment portfolio to provide you with
significant growth potential within the context of your individual risk tolerance.
So, any excess dollars kept in your rainy-day fund might be used to help fuel some
growth-oriented investments.
You
could also use these dollars to help diversify your investment portfolio. If
you only owned one type of investment, your portfolio could take a big hit if a
market downturn affected just that asset class. But by owning a mix of stocks,
bonds, government securities and other investments, you can help reduce the
impact of market volatility. (Keep in mind, though, that diversification, by itself,
can’t protect against all losses.)
Still,
before deciding on what to do with extra money you might have in your emergency
fund, how will you know if you indeed have too much? Up to six months’ worth of
total expenses may be adequate for most people — but everyone’s life is
different. For example, if you have reason to believe your employment — or that
of your spouse — may be in jeopardy in the near future, or if you anticipate the
need for some renovations to your home, but not for a year or so, you might
want more than six months of expenses tucked away in your emergency fund. Also,
once you’re retired, you may well want to keep a year’s worth of expenses in
the fund. If you need cash, you don’t want to be forced to sell investments when
their price may be down, especially since you have less time for them to
recover.
Ultimately,
when thinking about how much to keep in your emergency fund, review your
situation carefully and weigh as many variables as you can. And if you do decide
your rainy-day fund is abundant, use any “overflow” in a way that can help you
keep moving toward your financial goals.
Chad Choate III, AAMS
828 3rd Avenue West
Bradenton, FL 34205
941-462-2445
chad.chaote@edwardjones.com
This article was written
by Edward Jones for use by your local Edward Jones Financial Advisor.
Edward Jones, Member
SIPC
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