For anyone starting out on their personal finance journey, a common piece of advice is to set up an emergency fund. That is, save until you have 6 to 12 months of expenses or salary in the bank for rainy days. And that is before thinking about putting any money into investments. In How much cash or liquid assets should I hold in my investment portfolio?, unemployment can last for at least 6 months. Hence, this seems like a prudent approach for someone just starting off. But beyond this, nobody really tells you what to do as you accumulate other assets: Do you still need 6 to 12 months of cash in your emergency fund? Or do you need it at all? We can find the answer to this if we look at the true reason for holding cash in this way, that is, using emergency funds as self-insurance.
Emergency Funds as Self-Insurance for a Rainy Day
