The question sounds a little silly. I mean, can you ever really be too prepared for something? I believe you can, when the resources you’ve allocated to preparedness mean you can’t afford to do something else with your money.
Take emergency funds as an example. While I advocate most people save one year of basic living expenses in a liquid emergency fund, many others advocate living on much less. The old standard 3-6 months is still often touted as the way to go.
In this economy, with the average length of economy ranging from several months to a year, it just seems prudent to put away a year’s worth of household expenses – to keep the lights on, a roof over your head, gas in the tank and food on the table. In my opinion, anything less puts your family at risk of financial hardship should you lose your primary source of income.
Some people don’t get that message, and instead squander every penny the have that could go towards savings on something they want now. I get that. For a long, long time we operated our household at the edge of a very steep cliff, with no emergency fund, and we are lucky nothing serious like an illness or a job layoff came along and wiped us out (it wouldn’t have taken much).
The Extreme Saver
There are others who go too far in the other direction – allocating every single dime in their portfolio to cash savings. These folks often have several years worth of mortgage payments and expenses saved in cash.
That’s fine if it helps you sleep at night. However, consider the opportunity cost of simply parking that money in a cash-based investment vehicle earning less than inflation (which unfortunately is still the case even at the best online banks). Over time, inflation, and the further cheapening of the U.S. dollar, will conspire to erode your savings.
With our one-year emergency fund I largely ignore interest rates, because I don’t have money set aside to work for me. Rather, I have it set aside to be there if it hits the fan.
Rather than keeping three or four years of savings in cash, consider dropping down to a year, or two, as a compromise. The remainder can be invested in a variety of vehicles depending on your appetite for risk.
Five Places for Your Surplus Emergency Fund
Keep in mind, I’m only suggesting the following locations as options for money you’ve saved beyond your one-year emergency fund. I do not recommend these savings vehicles serve as your primary emergency fund because they are often exposed to more risk, and/or fees for withdrawal, etc.
Dividend stocks. Investing in dividend stocks with a 25-plus year track record of increasing dividends may be a good spot to park a portion of this money. By reinvesting those dividends of the long-term you can take advantage of compounding to grow significant wealth.
Roth IRA. If you are not contributing to a Roth IRA, use the first $5,000 to open one. And remember, Roth IRA contributions can be withdrawn at any time, so you may consider them an extension of your emergency fund, but with some additional risk exposure if invested in equities.
Real estate. If you have ever been interested in investing in real estate, now might be a good time to put some of that surplus to use. Rates are near an all-time low, and housing prices have not yet rebounded in many markets.
Gold and/or silver. I’m not one to push gold and silver often, but the case could be made for putting 10% or so of your savings into one or both of these investments. Personally, I like silver because it is still cheap enough for me to buy the real thing, rather than a certificate or exchange-traded fund that tracks the price of silver.
CD ladders. Creating a CD ladder is a smart way to boost the earnings on your cash savings without locking it all away under the threat of penalty for early withdrawal.
The bottom line is this, it is smart to save for emergencies, but do not allow an irrational fear drive you to only save for emergencies. There are other savings objectives that must be met to have a healthy portfolio such as college savings, retirement, rainy day funds (and sunny day funds, too!).