There are some really good thoughts on this topic here. Despite the differences in philosophy (cash cushion vs. springy debt), everyone here is very reasonable.
But I'll tell ya, look online for "emergency fund calculators" and you'll see crazyshit stupid things. "Calculators" that first want to know how much I have already saved. Hey - I'm trying to understand what I NEED - not give you a tasty entry in your lead database. I'm talking to YOU, Bankrate.com.
Seems some folks have a strange idea of "emergency". To me, a long-duration emergency, one that would require say a big 5 digit number to sustain for some period of months, is a time of sacrifice. Yet these "emergency fund calculators" prompt for monthly budget expenditures like entertainment and dining out.
Uh, excuse me but losing my job and being unemployed for 6 months probably means I'm throwing out those luxuries. I'm talkin' barebones folks - minimum debt payments (I have just a mortgage but I pay extra principal, but I probably won't in a true emergency), food, no new clothes, etc. Like, ya know, rough it! It's a fucking emergency!
I like the practical approach. Let's break it down by scenario:
Shit breaks: Like others said, if you have an "oh shit some stuff broke" moment, you'll pay via credit card. Most have at least 30 day grace period on purchases. No worries. 90% of the time this means that next paycheck will have less going into savings and more going towards the credit card (which you pay off of course). Emergency fund untouched.
Bigger Shit breaks: I have a septic issue right now that has a looming 5-digit figure attached to it. I know it's out there, I'll probably need to give it attention this summer. I'm pretty sure when the dude finally asks for the check I won't be surprised and have to sprint breathlessly to an ATM machine to give him cash. When I get an estimate I'll casually move some assets into liquidity, so I can write a check. This has happened recently for a car that shit the bed.
Catastrophe: Ok now the big one happens. I must admit I can't speak from any experience here, thankfully. My approach will be to rachet down life to barebones, and make weekly sell-offs (reverse dollar cost averaging) of equities to meet the household budget requirements.
No where here do I see a need for a "cash cushion" other than "feeling good". Therefore, to appease that feelgood feeling, make my wife feel safe, and get the better interest checking rate at my bank, I keep $10,000 in my savings account which is linked to my checking account. It also provides overdraft safety when cash flow is lumpy. The rest of my non-tax-deferred savings gets swept into investment accounts each month.
Try as a might, I see no reason why this cannot work except in the perfect storm scenario of a 50% market drop (hey you are diversified, right!?) and loss of job coincidentally.
Risk tolerance I guess.