The emergency fund
The emergency fund is three to six months of expenses in an account you can access any time. It isn't an investment, it's the condition that makes an investment sustainable in the first place.
The emergency fund is money that sits around being boring, and that's exactly the point. It's for broken washing machines, car repairs, dentist bills, and the chance that your income stops.
The common rule of thumb is three to six months of expenses. Note the word expenses, not income. If you need €1,800 a month, that's €5,400 to €10,800.
How much you need depends on your life. Secure job, no kids, cheap rent: lean toward three months. Self-employed, variable income, family, old car: lean toward six or more.
Where it sits matters. In a savings account you can reach within a few days. Not in stocks, not in crypto, not in a fixed-term deposit locked for years. The emergency fund isn't meant to grow, it's meant to be there. That it slowly loses purchasing power is the price of being available, and it's worth paying.
Economically, the emergency fund is an insurance premium paid in forgone return. With a €10,000 cushion and an assumed four-percentage-point return gap between a savings account and a broad stock portfolio, it costs you roughly €400 a year in expected value. Against that stands the damage from a forced sale during a downturn, which historically can quickly wipe out 20 to 50 percent of the affected position, plus the real risk of never getting back in afterward.
For sizing it, thinking in terms of shock types beats a single blanket monthly figure. Small shocks in the range of a few hundred euros happen often and get absorbed by the regular budget. Medium shocks of one to three months of expenses, like a car repair, happen every few years. Large shocks, above all a loss of income, set the ceiling and depend on your safety net and how quickly you could find work again.
On the question of availability: a savings account is accessible daily; a fixed-term deposit isn't. Shares of a broad ETF are technically sellable on any trading day, but their value at the moment you need the money is unknown, and that unknown is exactly why they don't qualify as an emergency fund. Availability without certainty of value isn't really availability.
Summary
- Three to six months of expenses, not months of income.
- In an account with daily access, not in the market.
- The loss of purchasing power is the price of availability.
Did you get it?
Is the emergency fund sized to your income or your expenses?
Your expenses. What matters is how long you could live without new income coming in.
Why doesn't a broad stock ETF work as an emergency fund?
Because while it can be sold, its value at the moment you need it can be unknown. That moment of need often coincides with bad market conditions.
What does the emergency fund cost you?
The forgone return. That's the premium for never having to sell at the wrong moment.
Related
- Savings accounts and fixed-term depositsStage 0
- What's left at the end of the monthStage −1
- Emergency fund calculatorCalculators