When it comes to managing finances, one of the first things suggested is to create an emergency fund to cover any unexpected expenses or loss of income. It’s great advice, but there are often overlooked downsides. Like the amount it takes out of a person’s income that they could be using elsewhere, this is especially true if they are saving a certain percentage from each paycheck.
A good rule of thumb when it comes to emergency savings is to have at least 3 months of living expenses, and 12 months should be the maximum.
One big reason people shouldn’t continue to save after the 12-month point is to leave room for other opportunities. After a person has reached a comfortable amount in their emergency fund, they should take the money that would go into that fund and invest it elsewhere.
This money can be used to fund aspirational experiences, such as a dream vacation, or even as a way to live abroad for a while. Or the money can go towards bettering the quality of one’s life, like taking time off to find a more fulfilling job or putting it towards continuing their education. This fund should be flexible, allowing the saver to have more freedom and choices.
Other downsides are that they can be straining on personal finances since saving for an emergency can potentially keep people from paying off their debts faster and freeing themselves from interest rates. By paying off debt first, they can then save even more for emergencies. There’s also the fact that most emergency funds are in accounts that aren’t earning them any extra money as other accounts or investments could. Imagine what investing that extra money could look like when it’s time to retire- it could equate to hundreds of thousands of dollars.
So while having an emergency fund is a good thing, pouring too much into that fund is not. Using this money in other ways could be the difference between a good life and a great one.