Building an emergency step is a bit like trying to run a marathon. You’re wishing for it to be over, but when it finally is, you’ve accomplished something major.

And it can be tempting to keep growing that fund, but there is such a thing as “too big” of an emergency fund.

Extra cash make us feel more financially secure - but it’s not always the best use of our money In fact, it can actually cause you to lose out with your finances in the long run. Here’s why:

1. Money in savings depreciates

If you’re earning interest on your savings at a rate that’s lower than inflation, then the money in your savings is decreasing in buying power over time.

The average savings account currently is providing a return of 2.74%. 

Let’s say, you’ve got $100 in your bank account at a 2.74% interest rate per annum. That means after a year, your bank balance becomes $102.74.

Inflation in the 12 months of March 2024 is 3.5%, which means you’ll need $103.50 to have the same purchasing power you originally did. 

So over the course of a year, your purchasing power has actually gone down.

Even if you’re using a savings account that pays more than 3.6%, the return you’re making on your money is probably super tiny.

2. There’s an opportunity cost

As great as high-yield savings accounts are, they’re not always the best at helping you build wealth.

In fact, the returns you’ll make on your savings are generally lower than the returns you’d make on an investment, like stocks or property.

A high-yield savings account will generally give you a return of 5%. 

Meanwhile, the property market has returned roughly 7% per annum for the last 10 years in Australian capital cities. 

And if we take a peek at the share market, the ASX 200 has returned around 10% per annum in the long term.

As an example, a $10,000 investment in the ASX200 over a twenty year period from 1993-2003 would have increased to a value of $138,778

That same $10,000 in a high-yield savings account earning 5% interest over the same period would only increase to $26,533.

3. Don’t forget about your debts

Before we get too excited about wealth-building, we’ve got to look at our debt situation first.

After building up your emergency fund, it’s a good idea to pay off high interest debt first. Think: credit cards, personal loans, BNPL’s.

Not only will you reduce your interest expense, but you’ll also be able to improve your credit score.

Once you’ve achieved this, the next steps come down to your personal financial goals and your risk profile. 

You might prefer to repay other debts like your student loan, or try to repay your mortgage faster.

Alternatively, you might have specific short-term savings goals eg. a holiday or some home renovations.

It’s a lot easier to save for those goals in cash, which is liquid and not prone to short-term downturns.