The Pros and Cons of the “Emergency Fund”: Reserve Funds – and If So, How Much?
The goal of building wealth has turned many into penny-pinchers. As long as it doesn’t harm health or social connections, there’s nothing wrong with advanced frugality—it could be worse habits.
It’s also striking that the same hardened savers often become sentimental in other areas and accept opportunity costs for the sake of “peace of mind.” This is the case with the “emergency fund,” which is often quite substantial. We aim to explore its sensibility here.
Leaving large sums of money—regardless of purpose—sitting in a checking or savings account causes opportunity costs. By consciously not investing this money in stocks, ETFs, gold, or Bitcoin, one knowingly forgoes very likely additional returns.
The intention behind this is clear: to avoid the hypothetical overlap of an unexpected, unavoidable payment obligation with temporarily depressed prices in one’s investments.
After all, one would then have to reluctantly sell stocks, gold, ETFs, or Bitcoin at unfavorable prices to meet this sudden financial obligation.
But is that really necessary? And if so, is partially liquidating investments more or less costly than the often indefinite holding of sometimes quite large cash reserves with the accompanying forfeited returns?
How Quickly Must Money Be Available in Emergencies in Germany?
Many proponents of emergency funds share the belief that sudden, unexpected costs, which apparently must also be paid immediately or within a few days, are realistic threats.
But how likely—or even possible—are such immediately payable bills that cannot wait until the next paycheck?
In typical transactions, including those involving private individuals, payment deadlines are usually around two weeks or longer. It’s also customary for creditors not to send a reminder immediately on day 14 but a few days later.
For instance, the EU Directive on Late Payment in Commercial Transactions sets payment terms of 60 or 30 days for invoices between companies or between companies and public institutions.
This primarily aims to address chronically late-paying public institutions and relieve companies. Yet, 30 days—or even up to 60 days between businesses—are allowed, not three or seven.
For consumers, the statutory payment term is 30 days unless otherwise agreed. The creditor can shorten this to two weeks, but even then, a reminder must typically precede further action. It’s even customary to issue up to three reminders before taking legal action.
Overly aggressive or short payment deadlines tend to meet with disapproval in court, as a certain level of proportionality and consideration of interests is expected.
Moreover, creditors are usually open to proactive communication from debtors and almost always grant payment deferrals. After all, creditors cannot be 100% certain they’ll recover the debt, and a request for a few weeks’ grace demonstrates responsibility and acknowledges the debt.
Potential Situations Where “Immediate” Money Is Needed
What situations might require immediate access to three-figure or higher amounts of money?
Classic Example: Washing Machine Breakdown (or Dishwasher, Stove)
If a washing machine breaks, costs of €350 including shipping are typical for a non-brand appliance. This hardly justifies holding several thousand or even tens of thousands of euros in reserve. Additionally, one could visit a laundromat once or twice until the next paycheck arrives. For child-free households, collecting dirty laundry and visiting the laundromat once may suffice.
Dishwasher: Handwash dishes for a while.
Stove: Use installment payments, payment deferrals, overdraft credit, or order and prepare cold meals temporarily.
Car, Bicycle, PC, or Smartphone Breakdown
The costs here are typically modest, or a payment plan or financing agreement can be arranged with the retailer. If not, a short-term overdraft might be an option.
Veterinarian
Even veterinary treatments usually cost only a few hundred euros. Payment deferrals or installments can often be arranged with vets. It’s advisable to discuss this before treatment.
Waiting Period for Initial State or Social Security Benefits
In these cases, arranging a payment deferral with creditors should be simple, as the situation is neither unusual nor intentionally created, and the debtor (the state) is solvent, making default practically impossible.
Broken Heating or Similar in Homeownership
Renters aren’t responsible for such costs, and homeowners don’t usually have to pay immediately. In these cases, an emergency fund would have to be very large and thus cause significant opportunity costs.
If the next paycheck isn’t sufficient, liquidating investments might be considered. This should yield better long-term returns than leaving tens of thousands of euros idle in savings accounts. Alternatively, banks are usually willing to issue loans for such cases.
Additionally, homeowners typically save for property maintenance. These funds could also be invested instead of sitting in checking or savings accounts.
Overdraft or Other Short-Term Credit Instead of Emergency Fund
Those with investments should have no major problems securing short-term loans or using overdraft facilities. Even without investments, but with regular income, this should be possible.
Fans of emergency funds seem to assume no one will lend them money in an emergency, despite having income and likely existing investments. This is often an exaggerated fear or stems from the desire to always be self-reliant and not ask for credit.
However, if the goal is to avoid liquidating investments, a loan can be economically reasonable. Banks are likely to agree if repayment capacity is evident.
This proud independence or fear of accountability can be expensive, especially with large emergency funds that sit unused for years. This approach should be reconsidered.
Appropriate Size of an “Emergency Fund”
Assuming regular income and existing investments in real estate, stocks, gold, etc., we consider an emergency fund of around €1,000 per household member and perhaps €300 per pet to be sufficient, given opportunity costs.
The reasoning is this: Failing to pay €300 within two weeks might raise eyebrows and hinder creditor cooperation. However, needing some leeway for thousands of euros is not unusual and shouldn’t lead to legal action or other consequences within a few weeks.
Gold – The New Savings Account?
Gold prices have risen steadily over the past decade from around €1,000 to €2,500 per ounce. Due to this consistent yet significant growth and its detachment from stock markets, it’s not unreasonable to consider gold a better savings account.
Gold could be held virtually as a Gold ETC rather than physically, allowing for quick conversion to cash. While gold’s value appreciation is not as perfectly stable as savings accounts, higher returns than the approximately 3% offered by savings accounts in late 2024 are to be expected.
Additionally, a significant drop in gold prices is unlikely. At worst, gold might move sideways for a time, making savings accounts retrospectively slightly better in certain periods.