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A couple of weeks ago, we had a fine discussion about how much we should save for retirement. But how much should we have saved for today? How much should we have in cash reserves?
As I write my own book, I’m reading (and re-reading) dozens of other money manuals. While perusing Bert Whitehead’s Why Smart People Do Stupid Things With Money, I came across his table of “minimum base liquidity”. (Whitehead is a highly-educated financial advisor. He uses terms like “minimum base liquidity” instead of “cash on hand”.)
Whitehead writes:
After making the commitment to save 10% of their income, the next question most people ask is, “Where should I be investing these savings?” The first goal is to have adequate cash reserves.
Many financial pundits in the media say everyone should have cash reserves equal to 3 to 6 months of income. For most middle-income people, that is simply a pipe dream…With our clients, I use a different and more realistic approach.
To Whitehead, adequate cash reserves differ depending on your circumstances. His “different and more realistic approach” uses a tiered system:
- If you are an employee with a regular income, you should have 10% of your annual income in a high interest savings account.
- If you are self-employed or your income fluctuates (through commissions, for example), you should have 20% of your annual income in savings.
- If you are retired, you should have 30% of your annual income in savings. (I’m assuming this means retirement income since if you’re retired you don’t have employment income.)
- If you’re in danger of losing your job, you should have 40% of your annual income in savings.
Whitehead draws a distinction between cash reserves and emergency reserves. I’m not exactly clear on what he thinks each is for. I get the impression that the cash reserves — the “minimum base liquidity” — is merely the minimum Whitehead believes we should have on hand to aid in our cash flow. This should also be used for occasions when the car breaks down or the roof leaks.
As insurance against severe emergencies, Whitehead recommends maintaining “emergency liquidity” equal to twice your cash reserves. (He also says to hold this money in retirement accounts, not savings accounts.)
Though I find certain elements of Whitehead’s plan confusing, I do like his tiered approach to saving. It makes sense to me that not everyone should save the same amount. Our circumstances and needs are different. As always, do what works for you.
For more information, borrow Why Smart People Do Stupid Things With Money from your public library.
You can compare the best savings rates from leading online banks in the savings & money market accounts rate table below.
This article is about Ask the Readers, Basics, Savings Wednesday, 7th October 2009 (by J.D. Roth)
October 7th, 2009 at 5:09 am
We have about $23,000 in our emergency fund and we are hoping to boost that number to $30,000+ by the end of this year.
What we did was look at our regular expenses for each month and socked away 6 months of those expenses. Plus we need more because we have investment properties so we’ve been adding more to our emergency fund to cover 3-6 months of expenses for our investment properties (i.e. all our properties were empty and we had to cover the carrying costs).
And we’ve been working to add more to our emergency fund just because the economy is iffy these days. While we both have good jobs we both know people who have been laid off and that motivates us to put more money away in savings.
October 7th, 2009 at 5:25 am
This is relevant to a question I’ve had for ages and have never found an answer to: what are these types of advised figures based on? Why 3-6 months? Why 10% of income and so forth? They all seem so seat-of-the-pants.
It is plausible (I’m not saying right, I’m saying plausible) that one does better in the long run investing more and holding less in cash reserve, even if one has to raid one’s investments for an emergency. It all comes down to how much return one forgoes by holding cash, the probability of an emergency, its expected size, and so forth.
Has anyone done a credible study of this? Such a thing would be really helpful as a basis for recommending a certain amount of cash holdings. Who knows, maybe 10% or 6 months worth or whatever is too little? Maybe too much?
October 7th, 2009 at 5:27 am
It is really different for everyone. I’m looking to have at least 6 months of expenses saved up in addition to saving for home and car repairs.
The problem with saving 40% of your income if you are in danger of losing your job is that you probably don’t have time to save that much up when you realize you are in danger of losing your job. I’d rather have it saved up before I’m in danger of losing my job.
October 7th, 2009 at 5:32 am
We have $20k in our emergency fund which is roughly 6 months of expenses. This might be too much but we feel better for having it.
We don’t have any high interest debt but our mortgage is 5.19% so there is a cost to having such a large EF.
October 7th, 2009 at 5:47 am
Does he really mean 40% of your annual income or 40% of your annual expenses? If your income is much higher than your expenses it seems like your income would not be a good figure to use.
October 7th, 2009 at 5:54 am
Amen #2! How about the logic behind the particular numbers?! And, if there is none, just tell people to save enough money that they feel confident in case of an emergency? Some people are very risk averse, some are not.
October 7th, 2009 at 5:55 am
I agree with the Incidental Economist. It seems a little silly to have a large-ish chunk of cash sitting in a savings account making very little in terms of interest, in case of an event that may or may not happen.
It makes more sense to have a reasonable amount in a savings account (maybe a few thousand) to cover those smaller emergencies that do tend to happen - car repairs, house repairs, emergency trips. And the rest invest, and in the event you have a large emergency (you lost your job and cannot replace it quickly enough), then take money out of your investments and eat the loss.
I would rather chance a small loss or fee if I have to sell an investment for a infrequent (or maybe never) emergency situation, than tie up a much larger amount of money indefinitely in an account that makes no money.
October 7th, 2009 at 5:57 am
I read recently that according to one study the average job search was 6 months. I wish I could include the link, but I really don’t know where I saw it. For me, the emergency fund is to cover bills and rent in the event that I loose my job. So I see 6 months of expenses as being a goal to shoot for. I don’t want to be overly optimistic and think that I can find another job in a month or two.
October 7th, 2009 at 5:57 am
I like it when you cite people by whose standards I’m saving too much :).
I don’t think I’m in imminent danger of losing my job, but I’m over 45 and have been working at the same place for a long time, so I would be pretty worried about being able to find another job at similar pay if I did. I’m definitely more comfortable having a full six months of income (actually a bit more) fairly liquid. I could probably get by for a year on that.
October 7th, 2009 at 5:59 am
Interesting approach. I’m glad there’s advice out there that at least addresses the fact that we’re all different and there’s no magic number we should all aim for.
Incidental Economist (#2),
Your approach is something I’ve considered as well. While there is inherent risk in the stock market and you probably shouldn’t have your whole EF there, I don’t see any reason why, with a solid plan for how you will use it, you shouldn’t necessarily invest a portion of your emergency fund above and beyond a set amount of cash that you keep in the bank as a back up.
October 7th, 2009 at 6:05 am
@ The Incidental Economist (#2)
Regarding the question of how large your emergency fund should be and the rationale for that size:
In my household we have an emergency fund equal to our living expenses for the period of time we must support ourselves before our Long Term Disability Insurance kicks in - in our case 90 days.
Hopefully it is never needed, but if one of us becomes disabled (in a car accident or something) we can still survive until we get our insurance claim.
This makes sense to me, but (as always) do what works best for you.
October 7th, 2009 at 6:08 am
@The Incidental Economist — based on my personal job history, the 3-6 months of expenses represents a “best guess” amount of time that you might be without steady income. Of course, the times we are in now are pretty unreasonable with jobs being more scarce and hard to find. Of course, it was also unreasonable in the dotcom era, with effectively zero unemployment.
I would disagree with putting emergency funds in retirement accounts. Getting an additional helping of pain from the IRS on an early withdrawal on top of dealing with some emergency just makes things worse. Emergency funds should be instantly available and not subject to market conditions. I guess, though, that it could be a barrier to having “a new TV”, “a new pair of shoes” or “Christmas” be called “emergencies”.
It also seems funny that the author calls 3-6 months of income some kind of pipe dream and then advises to save what will likely be a similar amount of money, anyway — since expenses and income are not the same thing at all. One thing his plan has is more simplicity — you take XX% of your income and that’s the goal. The 3-6 moths of expenses implies you have some kind of budgeting system, which means more work — and many people just don’t do that.
October 7th, 2009 at 6:09 am
I agree with Adam; you can’t go from 10% to 40% in the time it takes to find out your job is in jeopardy.
Christine, these percentages (10%, 40%) seem low to me; I guess that already accounts for the fact that absolutely required expenses are often much lower than income?
For people that don’t follow web sites like this, suggesting a blanket percentage of their income may be the only way to get them to address the problem. I think most people following this site would look for something more customized, such as the following:
Figure out how much it costs to live every month without you and your spouse killing each other or having anything repossessed then save for n months of that, where n is 3-12 months based on ease of finding a job (relatively small n for nurse in metropolitan area; relatively big n for autoworker anywhere).
Treat emergencies like roofs and heat pumps and transmissions as a different issue, as they hurt even if you have a job.
October 7th, 2009 at 6:12 am
I like Bert Whitehead; he’s a bright guy, but the defined “adequate cash reserves” are not really much of a deviation form the 3-6 months of necessary expenses (Whitehead compares it to 3-6 months of income, but most promote 3-6 months of necessary expenses, not of income).
When you consider that a 50-30-20 budget results in half of your after-tax income allocated to your needs, 3 months (one-quarter) of that amount is going to be about 10% of your annual gross income, the same as Whiteheads minimum. 20% is about 6 months of needs. And most agree that if you’re in danger of losing your job, a year’s worth of necessary expenses (about 40% of gross income) is smart.
I’m not sure I understand the one for retired people either. I think that’ll really depend on the sources of income like pensions, social security, and part-time employment compared to the amount you withdraw from your own nest egg each year. I think it makes sense to maintain 100% to 500% (a 1 to 5 year withdrawal cushion) of that amount in cash. This ultimately depends on risk tolerance as it is easier to ride out bad markets knowing you’ve got the next 4 or 5 years worth of withdrawals already in cash.
I generally define “cash reserves” as money you plan to spend to aid in cash flow, like for quarterly or annual expenses such as vehicle maintenance, insurance premiums, and estimated taxes. An “emergency fund” is for the unplanned expenses, and therefore must be above and beyond the planned needs for the cash reserve.
October 7th, 2009 at 6:14 am
I have about a year’s worth of expenses in saving right now - with how bleak the job market is, if something happens where I work, or worse, I get injured and can’t work, I want to know that I’ve got enough set aside to last more then “just a few months.”
As the economy turns around, the amount I have saved will fluctuate I’m sure, but for now, it’s where I’m most comfortable. Rather have more then less.
October 7th, 2009 at 6:18 am
The savings guidelines seem nice on paper, but you can be a regular employee with 10% saved, and 24hrs later be in danger of losing your job with anywhere from 2 weeks to 2 months to prepare. That is not enough time to beef up your savings to 40%
I think the concept is great, but there are way to many factors to consider: marriage, children, other assets, career field (how quickly can you find another job), etc
Kita
October 7th, 2009 at 6:21 am
What is missing is that an emergency fund should cover the approximate time it would take to find a new job. That might take one month for some and up to a year for others. Plus - I disagree that it should be a certain percentage of your salary. The emergency fund should cover your expenses for the time period you think you will be unemployed.
October 7th, 2009 at 6:26 am
When people ask me this question and then balk at my 6-12 months of living expenses answer, I tell them they should save whatever amount allows them to sleep easy at night.
Personally, my cash at hand is about $5k…because that’s what I need in my checking account for the bank to waive the monthly fee. Emergency funds are a little sad right now because I have the mortgage in the cross hairs, but I’ll be ramping it up next year. I won’t feel entirely comfortable until that emergency fund is close to 6 figures, which means I’ll need about two years to get it together.
October 7th, 2009 at 6:38 am
@2: I figure that 3-6 months is the amount of time it’d take a reasonably employable person to find a new job if he or she was laid off. And you might be right, for example I know if I cash in my 1-year CDs my penalty is 3 months *interest* so unless I cash in within the first 3 months I still come out slightly ahead. That’s just one example. I’d anyways want it to be still fairly accessible and most of all safe (CDs yes, stocks no).
@3: I agree! on all points.
@4: Yeah, but you can’t anticipate now when you might be insanely glad you did that. Only in hindsight. I say whatever works for you is what works. I’d feel great if I had that much too!
October 7th, 2009 at 6:42 am
I agree with Adam and Lakita; it’s not reasonable to think you can boost your emergency fund by 20-30% of your annual income from the time that you learn your job is in jeopardy until you actually lose it. That’s the point of an emergency fund - it should already be in place when the emergency strikes.
From the responses I read here, it sounds like most people already have their emergency funds saved, it’s just a question of where. Some have it in stocks, others in cash, and still others in retirement accounts. For a long time I counted the credit available on my HELOC as my emergency fund and a year ago changed my way of thinking when the market crashed. I am scrambling to save 6 months of expenses. I’m halfway there. Since I budget, it’s easier for me to consider 6 months of expenses than to consider an ambiguous 10-40% of income. I don’t know how safe my job is. If I thought it was genuinely in danger, I’d be looking for a new one.
October 7th, 2009 at 6:42 am
I agree with many of the comments posted, that 40% is arbitrary if you lose your job within a matter of months and didn’t see it coming.
It’s great to promote saving 10% or more of your income, but I think this scares people off initially. Many people will automatically think, “I can’t save that much!” Maybe a better tiered plan would start with baby steps, sort of like Dave Ramsey’s $1,000 emergency fund. Then, the tiered plan could build upon a solid number and eventually get to that 10% or more.
It’s just a thought. I see 10% and I shutter. My husband and I are saving for a down payment on a house, and we’re not saving 10% at the moment.But, it’s a great goal that we’re looking forward to.
thanks for the post-
Little House
October 7th, 2009 at 6:47 am
This article outlines the approach my wife and I have taken. We have cash reserves and true emergency savings in some Roth IRAs. There is no penalty for withdrawing principal from a Roth so in a real case of an emergency these funds are available almost overnight with no penalty. We also pay no tax on the interest I earn. We can alway place funds back into a Roth up to the yearly limit.
The one key piece missing from the whole equation is lines of credit. Like most people I have a credit card but you can also have a line of credit on your house which you can draw on at any time. These are generaly fee free so they cost you nothing.
This credit provides another source of emergency funds which as long as you have emergency fund to back it, it is not risky. This provides options when you need them the most. In an emergency liquidity is important.
As for putting funds in investments. I think the last year clearly indicates when you need cash the most your investments might be held at a loss (your EF is less than what you actually saved). EF should only be invested in almost risk free vehicles. CD’s are great options as long as a bank allows you to borrow against the CD if you need the funds immediately or allows you to pay the penalty. Although, cash is alway king.
October 7th, 2009 at 6:49 am
I strongly agree that the reserve account needs to vary depending on the circumstances of the individual involved. There never can be one rule.
I am coming to believe that rules of thumb do more harm than good. They are great for marketing purposes. It makes the person giving money advice appear smart for him to cite an official rule of thumb. But it hurts the people following the advice to do so. First, the rules of thumb are often dangerous for a large number of the people following them. Second, hearing a rule of thumb stops thinking in its tracks. These questions are not so difficult. People could come up with reasonable guidelines on their own. But they hear the rule of thumb from a Big Shot and cut off their own thinking processes.
Rob
October 7th, 2009 at 6:54 am
Someone I admire took an incremental investment approach regarding her emergency savings. First she saved 10-months worth of essential expenses (mortgage, car pmt, utilities, insurance, etc.)funds, figuring her unemployment, a part-time interim job or disability would cover other basics like groceries. Then she placed 1/10th of the total savings into a 6-month cd each month for the next 10 months, while continuing to save, so that by the time she reached month 11 & 12 she had saved funds for those months as well. Each month that passed without need, the cd’s were allowed to renew for another 6-month period. Should the need arise, she has created a monthly emergency fund she can access without penalty for the next twelve months. Considering the longest she’s ever been unemployed or laid up is 60 days, she feels pretty confident about her ability to weather the storm.
October 7th, 2009 at 7:14 am
I love these kinds of posts and I think they present great ideas. Right now I am in a quest to achieve financial stability. What about those who are drowning in debt? Bad debt? It’d be great to see some posts about what to focus on first. Should you still save when you are underwater?
Thanks as always for the thoughtful posts.
October 7th, 2009 at 7:26 am
This seems very low to me. In the past few years I’ve had 5+ friends in various fields who have been unemployed for at least a full year. Yes, there is unemployment insurance for a while, and yes, if you must, you can tap your retirement accounts, but don’t forget that some expenses can actually increase when you lose your job - especially if you have a family and you lose your employer-supported health insurance.
Of course, maybe that proves JD’s point: different amounts are appropriate for different people.
October 7th, 2009 at 7:31 am
@Rob, I agree rules of thumb can do more harm than good and that people generally stop thinking when they hear one. However, that’s not the fault of the rule of thumb or the person quoting it. Rules of thumb, just like statistcs, are not inherently evil, bad, or wrong. They should be used as a starting platform for your own thought process. Like you said, people who hear a rule of thumb and stop thinking are the ones to blame.
I know it’s sort of a subtle difference but it’s important because it places the responsiblity on us to think for ourselves and not blame someone or something else for circumstances within our control.
October 7th, 2009 at 7:32 am
This post is interesting, and Id like to offer a follow up:
Assume your in your mid 20s, able to cover all expenses, fully fund an IRA and contribute to your 401K up to your employer match. You dont own, you rent a place, so have no mortgage. You are able to save nearly 100K over the next 5 years.
What do you do with this money, aside from letting it sit in an ING account?
October 7th, 2009 at 7:37 am
Is this 10% of your gross annual income (or is it income post 401K, post taxes and 401K)?
October 7th, 2009 at 7:47 am
@ Incidential Economist
The average time from search to job is around 6 months. That’s why its used. It’s not exactly that for every person, but its a rule of thumb.
I disagree that you should invest buffer funds. Investing a buffer fund could be a ST investment and that is very subject to wild swings.
October 7th, 2009 at 7:54 am
@Little House - that’s an interesting way of doing things, saving money in laddered CDs which then essentially gives a payout each month. I have considered a similar path, but I don’t want to tie up my money that way. It works if the emergency is the loss of a job. However, there are other types of emergencies. For instance, a new transmission, a medical emergency, a special assessment if you’re in a condo, or travel to a funeral. With laddered CDs you may not have enough money and then you’d have to pay credit card fees until the CD comes due.
October 7th, 2009 at 8:15 am
To restate/clarify my original comment (#2):
If average job loss is 6 months, that’s somewhat of a justification. But that’s just an average. Why be satisfied with the average? What is the distribution? What is the variance? What is the median?
Let’s be honest, 6 months is a guess. It is a way of making us feel safe. But is it prudent? Is it too prudent?
All I seek is a credible study on optimal emergency fund size and trade-offs for various sizes. It would be a valuable contribution. I wish I could do one myself but I am in another line of work.
If anyone knows of literature on it, please contact me through my blog. I’ll write about it.
October 7th, 2009 at 8:18 am
I’m going to still be paying off my debt for the next 6 months or so, but I imagine once I am out of debt, I will save towards the 6+ months of emergency fund and keep it in a high interest savings account, as well as keep several grand in my chequing and/or other high interest savings account just to have a nice float and not have to dip into emergency savings for things I might need to buy.
After that, I will look into retirement savings. Maybe I will even start contributing to an RRSP (Canada) or some other retirement account before I get my 6 months’ worth of emergency savings. I will have to see. I also want to save money for the company I want to start, and of course I want to learn more about investing so I can start on that too. Luckily I’m in my early 20s so I hopefully can do all this relatively fast and have a nice, early, comfortable retirement
Perhaps 6 months’ worth of expenses is quite a lot to have in an emergency fund (for me right now I’d be comfortable with $15,000 or so saved), but after people keep losing EVERYTHING in the stock market, that slightly smaller amount of interest I’d be earning offsets some of the worry of having it in a higher risk place and losing it…).
October 7th, 2009 at 8:28 am
@Suzanne–I have a CD ladder as “unemployment insurance” and also a smaller emergency fund in a savings account for car breakdowns, etc.
October 7th, 2009 at 8:29 am
It is a difficult decision and the reality is if you have that problem of possible saving too much, that’s an amazing problem to have. Being in mid 20’s and in the balance of work, life, fun and future it is difficult to begin saving when expenses are high and the future isn’t a reality in our mindsets.
October 7th, 2009 at 8:30 am
@ebyt - you might consider a Tax Free Savings Account. You can save up to $5000/year without getting dinged by the tax-man.
October 7th, 2009 at 8:34 am
I agree with Alexandra above. With all this focus and discussion on the amount of the emergency fund, people are not spending enough time looking at the allocation of the amount. While its great to have a boatload of money saved away, there is little point to putting it all in cash or cash equivalents, paying a crap interest rate.
Why not put the amount most likely to be needed (for me its the cost of buying a used car) in a cash account, and then put the rest in a diversified bundle of higher returning investments? I have enough money in such savings to cover years of expenses (which will eventually be turned into an early retirement fund) and am absolutely 100% as safe as someone with 6 months worth of savings earning nothing on a boatload of cash. Realize that by letting so much money sit in cash, you are incurring a tremedous opportunity cost while gaining nothing in the way of additional financial security.
October 7th, 2009 at 8:46 am
I guess I’m “lucky” but honestly I feel I’ve just made great choices (along with many bad ones), and one of those choices has been my employer. I chose to work there because they treat their employees fairly. I would have NEVER thought I’d be with the same employer for as long as I’ve been at this one (9 years next month), as it usually means cheating yourself out of market value compensation, but I’ve managed to get promoted several times, several ‘market adjustment’ pay raises on top of that, and for those folks (all deadbeats) who have gotten laid off from this company they all got healthy severances, more than enough to get them through 3 months of expenses.
I have $10k in cash saved for emergency fund and I feel it’s too much. I have disability insurance, so if I got hurt I’d be able to survive. Losing my job without severance isn’t a real concern for me. So for me, I’m seriously considering taking $5k of that emergency fund and putting it into non-retirement investments.
I think that if you have disability insurance, and are not one of those with so much pride as to not take a part-time lower-wage job while job-hunting, then 6 months’ of emergency fund is just too much.
October 7th, 2009 at 8:47 am
@ 28
I suggest you go to 20smoney.com. The whole website is dedicated to financially responsible people who are in their 20s, have almost no debt, are fully contributing to their 401k and are wondering what the next step is.
October 7th, 2009 at 8:54 am
I still think having a separate “emergency fund” as opposed to any other sort of savings is fairly pointless. Sure, you need emergency savings, but if you actually *have* an emergency, then pulling from your “house down payment” savings account is functionally identical to pulling from your “emergency fund”.
I don’t keep a special emergency fund account, because if something drastic does happen, there are other places I can pull money from.
October 7th, 2009 at 8:59 am
@Tyler Karaszewski - That only works until you buy the house (or what ever else that savings is for).
October 7th, 2009 at 9:00 am
@ The Incidental Economist:
It’s difficult to study optimal emergency fund size, because of differing definitions of a) what an emergency fund is and b) what an emergency is. But here is a paper exploring the tradeoff between liquidity and yield of funds:
Should Households Establish Emergency Funds?
Charles B. Hatcher (2000)
Hatcher finds that the probability of an emergency has to be relatively high (greater than 1/yr) - even with quite a low spread between the yield of a low-risk, high-liquidity investment and yield of a high-risk, low-liquidity investment - for the borrowing costs to outweigh the lost yield. But, remember that he is writing pre-2000, before the last 2 recessions. And his example of a low-liquidity investment is a 1 year CD, meaning that you have to borrow for up to a year before you can access it. Right now the spread between liquid savings accounts and CDs is lower than he probably anticipated when he did the study.
The formula he offers is quite useful, though.
October 7th, 2009 at 9:14 am
I don’t expect people would argue about having a savings fund, but a lot of people today have ZERO savings and foresee never having any.
October 7th, 2009 at 9:34 am
@Tim, #22: You say: The one key piece missing from the whole equation is lines of credit. Like most people I have a credit card but you can also have a line of credit on your house which you can draw on at any time. These are generaly fee free so they cost you nothing.
***************************
This is WRONG. One of my co-workers relied on his HELOC to pay his property taxes, and he was diligently paying off other credit lines. When it came time to write a check from the HELOC to the taxes, the bank had REDUCED his LOC because house values have plummeted.
To get the taxes paid, he had to pull on a ST LOC from USAA, and now he has even more debt.
DO NOT RELY on a LOC for your expenses or your emergencies. There is no guarantee that it’ll be there when you need it - unlike cash.
October 7th, 2009 at 9:34 am
Here’s my version of the CD “ladder”:
Instead of having to worry about renewing a CD every month, I created what I think of as a CD “bridge”. I put most of my EF into one CD that was paying a good rate. I then opened two smaller (5K each) CDs for the same term. If I need the money, I can use one or both of the smaller deposits. The result: better interest rates, less renewal hassle, same access to my money if needed. Alas, they’re all coming due soon and the good rates will be gone, but that’s a separate issue…
October 7th, 2009 at 9:37 am
Some really good feedback in the posts above. I like the laddered CD idea, smart play with your money. I do agree though that one should have a small cash reserve on top of that to handle a leaky roof, blown water heater, new exhaust kind of thing.
When I first started out in my career I always had a EF of at least 6 months of the bare minimum expenses. In my field I notice that most people take about that long to get a job. If you don’t know your field well enough to know about how long it takes to get a job start looking around NOW and save accordingly.
I mention when I first started out because I have found ways to help with job loss issues by starting other business, rental properties, etc. By spreading the income sources I minimize the risk if one dries up. I only keep about $10k liquid now, the rest is fully invested in some form or another. If I need more I have other sources of income and/or I can divest pieces from a rather large portfolio that is well diversified.
Some people mention not saving as much because of unemployment covering some of the expenses. REMEMBER, not everyone gets laid off, god forbid that you get fired! No unemployment then. I thought it would never happen to me but I joined a company and through some quick changing politics ended up working for a new SVP that was a real moron. We never saw eye to eye and in short order he fired me. I managed to talk some sense into HR and they treated it as a lay off with minimal severance. Had they not done that I wouldn’t have been able to get unemployment. Fortunately I saw it coming and was prepared with a new job that started about six weeks later.
That’s another thing folks, if things are going south at your work you should be aggressively looking. Don’t put your head in the sand and wait for the inevitable. It used to be you could expect employers to treat their employees like people but today we are just commodities. Be aggressive and plan not only your emergency fund but work your job network, keep your resume up to date and keep your feelers out.
As far as investing your EF… I would NEVER put my EF into my retirement funds, NEVER! Those have always been sacrosanct to me, never shall the two meet. I don’t want to be penalized for withdrawals, I don’t want to ever be tempted, that money stays there always!!!
That said, I have always invested the bulk of my EF in my brokerage account. If you don’t understand the market at a minimum you should consider a laddered CD approach. Don’t let your money sit around earning bare minimums in interest.
Finally, NEVER, EVER consider your Line of Credit of any kind as part of your emergency fund. People are seeing their lines of credit being cut off, whether it’s HELOC’s or CC’s. In this economic climate that is a very foolish way to plan for an emergency. It could very well be gone when you need it most.
October 7th, 2009 at 9:38 am
To answer your question (the title of the blog post) - it depends….
What are you saving for?
A house? - then shoot for 20% of the estimated cost, plus closing costs (usually another couple %)
A car? shoot for the cost if you want to pay cash, or at least a sizable downpayment plus taxes and registration fees
A medical emergency - what’s your annual out of pocket maximum?
A job loss/unemployment - how long does it take the average person in your field to find work? Take that # of months multiplied by your fixed monthly expenses.
These numbers are different for everyone, there is no cookie cutter answer.
October 7th, 2009 at 9:47 am
@Mark #38
“I feel I’ve just made great choices (along with many bad ones), and one of those choices has been my employer.”
Be warned, circumstances can change. Companies can be bought out by others who are not quite so ‘nice’. This has happened to my husband. A year ago the lay-offs started, but my husband felt ’secure’ because he had a contract for 6mths severance. We are a family of five and this is our only income.
I was not so certain, so I set a goal to pay down debt, save an EF and still contribute to our 401K and IRA’s. It has been very tough, but last week we became debt free except for our mortgage. We have 20K in EF savings and are owed 12 weeks holiday pay.
In four weeks time my husband will be unemployed. His company is refusing to honor his contract and we have had to take legal action. These costs are now denting our EF.
Right now, where our fund sits is unimportant. Having it is vital. I am expecting increased medical costs for our children, who all take regular medication, when we lose our insurance and a potential 6mth period without work (it’s a jungle out there.) Only time will tell if we’ve saved enough to survive. When the chips are down, you want peace of mind. Knowing you have amble funds, accessible when you need them and for whatever amount you need is what helps you sleep at night.
October 7th, 2009 at 9:53 am
I was going to mention the idea of staggered/laddered CDs, but a lot of folks beat me to the punch.
October 7th, 2009 at 9:58 am
@Dylan: Yes, that’s true if you only have a single account with savings, and you empty the entire thing.
October 7th, 2009 at 10:13 am
@The Incidental Economist — speaking particularly in response to your #32 question, a huge part of money management isn’t just about facts and figures. It’s about behavior, goal-setting and habits. It’s also about iteration and re-evaluation of your current position. Telling someone who is getting started to save 10% of their income, 3 months of expenses or even $1000 when they have NO emergency fund whatsoever gives them something to do and develop some fiscal discipline. Asking too many “why?” questions leads to “analysis paralysis”, where you keep on sliding on in the same manner, with no progress towards any goal being made.
It’s not like the money pops into existance overnight, anyway. Maybe you decide “I’m going to save up $1000 because that’s what Dave Ramsey tells me to do”. So you start doing it, and then at some point, you have $1000 in the bank. You’ve likely never had that before. And you’re now somewhere along the path to being in better financial shape.
All this talk of CD ladders, stock market, retirement funds, HELOCS and so on can be VERY overwhelming for someone just starting to try and get their stuff together. If you have a basic checking/savings account, though, you can start saving money today — and it’s much more probable someone will take that action than doing something elaborate.
I’ve found as we’ve become “better” financially, we become more educated consumers. I’ve also discovered that I’ll very easily say I’m going to look into something “tomorrow” and never get to it. Sometimes the easy choice is “good enough” — and most of the time, if it’s not “good enough”, it can be changed later, anyway. Every decision doesn’t need deep analysis. There simply isn’t time.
October 7th, 2009 at 10:25 am
@Tyler (#40) — we create separate sub-accounts of saving to deal with saving up for multiple savings goals. In addition to the bread-and-butter “emergency fund” where we keep our X months of expenses, we have separate funds for large home improvement projects, my wife’s further education, saving up for a new car and saving up for an anniversary trip next year.
Yes, all this money can be pulled from in the event of a truly large emergency. Where the categorization becomes useful is when we have either “windfall” type income or income from semi-regular but unknown amount sources (bonuses). Also, some of the goals are more variable than others — for example, we can readily forecast the both the cost and timetable of the education fund, although the car and home projects are less well-defined. The anniversary trip has a date, but can vary in duration and extravagance based on the amount in it
When I was single, this was not so complex. I had checking, savings and retirement. With a wife and children, things require the agreement and buy-in from my wife about how we are allocating our money to meet shared goals.
Note that this only applies to our savings — we also do a monthly budget, plus contribute to retirement funding.
October 7th, 2009 at 10:28 am
A few comments:
1. I dont get the point of a cd ladder. the rates for a 6 month cd are not much better (if at all) than an online savings account. Why go thru the hassle of opening and maintaining all these cds when the money will earn the same interest in a savings account?
2. Relying on a heloc or a credit card to deal with emergencies just means that anytime an emergency comes up you have to go into debt! to me that the beauty of an emergency fund - you dont need to go into debt when something bad happens. that is your piece of mind.
3. There are so many variables for peoples personal situations that a 3-6 month rule of thumb for savings is pretty useleess. The amount of money that should be saved should be whatever makes YOU comfortable. For some that might be 3 months worth of expenses, others a full years salary. Do whatever feels right for you…
October 7th, 2009 at 10:47 am
Jason (#51)’s post reminded me of a recent analysis showing that for low and middle income families (<50k a year), having $500 in emergency funds is a fairly good splitting point in terms of predicting the gains you would want from an emergency fund on a day to day basis, such as fewer worries about money and reduced impact of money concerns on health. In other words, getting over the $500 threshold is more important than getting over the $1000 or 3-month threshold in terms of reducing financial worries.
Within the same group of low and middle income families, having a $500 emergency fund is also associated with more positive financial behaviors in general, such as regular contributions to savings and keeping a budget.
http://www.consumerfed.org/pdfs/Emergency_Savings_Survey_Analysis_Nov_2008.pdf
October 7th, 2009 at 10:51 am
@ Tyler Karaszewski: True, but if you never allow yourself to empty the accounts or let them go below a specific minimum (incase of emergency) then you have an emergency fund. It might be commingled with other funds, but you are still accounting for an amount of money to be kept incase of emergency.
October 7th, 2009 at 11:03 am
Oy this all makes me dizzy. I have money spread around several savings accounts, but none is established as a “touch-not” EF. I have been contributing $500/mo to a general savings account which I raid for car repairs, school fees (which get reimbursed), and most recently a long-overdue trip to visit my grandmother. It’s effectively at 0 right now. I have $2500 in an account to pay property taxes and insurance; both are due in the fall so that will be cleaned out. I also have $2k in laddered CDs; this money was a wedding gift and I would like to save it for a real honeymoon.
So starting now I’m shoving that $500/mo back into that general account. I’ll have to put some of it towards next year’s taxes and insurance. Holidays are always a hard time to save, but starting in ‘10 I will split off a separate “no-touch” account and start shoving some in there.
I’m also thinking of buying into a moderate risk mutual fund. I put about 15% into retirement accounts, but my husband is much older than me and we might need some medium-term savings - he has no retirement saved. I’m looking at T. Rowe Price’s “balanced” fund. If I get a raise in ‘10 maybe I’ll just put it there.
October 7th, 2009 at 11:12 am
We decided we were comfortable with around 3 months of expenses in our emergency fund, so we have about $15,000 set aside in there right now. We are also saving for our next car (no more car payments for this family!) so we have extra cash on hand at the moment.
I just posted on my site about a marriage retreat my wife and I attended over the weekend. When discussing our goals and our “dream marriage” it really hit me how appreciative I am that we decided several years ago to make our family finances a priority. It has set us up to take steps toward our ideal lifestyle!
October 7th, 2009 at 11:17 am
@ sandi_k #44
Sorry to hear about your friend.
First, your friend did not have a LOC when they needed it and that does not make my statement false. Your friend should not solely rely on credit as an EF.
Second, if you read my comment the LOC is one option.
I stated: “This credit provides another source of emergency funds which as long as you have emergency fund to back it, it is not risky. This provides options when you need them the most. In an emergency liquidity is important.” (some bad grammer but typing fast)
Risk is a term I should have defined as potential to cause financial hardship. You should have the EF to back you credit. CDs are an example of an asset that may not be immediately accessible without penalty. It may make more sense to pay the interst on a LOC versus taking the penalty. This gives you more options, not just one option in which your friend was relying upon.
October 7th, 2009 at 11:29 am
Just becaue you want 3-6 months worth of emergency funds doesn’t neccesarily mean it has to be sitting as a cash balance in a savings account.
You could always set up a CD ladder, where in any given month, you could retrieve 1/6th of your emergency funds with no penalties. It’s obviously not as liquid as cash, but if the purpose of your emergency fund is to cover expenses in an unexpected situation over a long period of time, it should work out fine while gaining a few extra percentage points worth of interest for you.
October 7th, 2009 at 11:34 am
This is kinda funny. We rented Whitehead’s PBS special by the same title a year or so ago. Ironically, we had a hard time gathering the basis of his theories and found a lot of it just plain confusing.
You can read our review, but we could only tolerate about 18 minutes. I was hoping maybe his books would be better, but those aren’t looking so hot either.
As for us, I believe we are fully funded to 5 or 6 months of expenses. Bert’s need for a ‘different’ is odd. 3-6 months of expenses into an emergency fund is only a pipe dream if you’re not out of debt. Which makes me wonder what exactly Bert is teaching his clients. Also, his tiered approach, while different, seems to be totally disconnected from reality and based on arbitrary figures.
“Whitehead is a highly-educated financial adviser. He uses terms like “minimum base liquidity” instead of “cash on hand”.”
I think I have to agree, smart people really will do stupid things with money.
October 7th, 2009 at 11:35 am
I cant get past Whitehead’s comment about 3 to 6 month EF savings a “pipe dream” for middle class. This middle class family has achieved it. It is a matter of figuring out what your family needs and setting goals. Sorry but this guys quote alone makes me not want to read his book.
October 7th, 2009 at 11:43 am
Again, as others have mentioned already, that amount will depend on each person’s comfort level. For me personally, I like the idea determining the emergency fund amount as it relates to the current unemployment rate. For example, California is currently at 11-12% unemployment, so that means I must save around 11-12 months worth of expenses. I don’t think that there is really a mathematic correlation between the two, but it’s what make me sleep better at night.
October 7th, 2009 at 11:46 am
And how much should full-time students have in savings?
October 7th, 2009 at 12:19 pm
I keep around 3 months of expenses as liquid cash (actually, as laddered 6 month CDs with alternating months), and invest the rest of my “emergency fund” in a manner that’s quite aggressive to most, but comfortable for me — in a no transaction fee largecap international index fund.
I began this approach in late 2008, fortunately for me (big gains)– but even if I hadn’t been so lucky with market timing, the fund only fell 35% or so and has recovered more than half of those losses.
Can I be assured that I will have a fixed amount of money in a true emergency? No. Do my savings have an inherent yield, are they marginable if I need a short term loan, and otherwise quickly convertible to cash? Yes.
I’m willing to accept some substantial volatility for the long-term upside — but my approach is not for everyone.
In total, I keep around two years of expenses invested in this manner.
October 7th, 2009 at 12:20 pm
@Student H — well, the simple answer is zero since you have no income :). I guess this question might have more to do with keeping a solid budget, though. As a student, you know what a lot of your upcoming expenses are going to be — you have
- academic stuff (tuition, books, fees)
- housing expenses (apartment/dorm room)
- food
- travel (do you fly home at Thanksgiving, Christmas, end of term)
- fun money
Your “income” is likely composed of money from loans, money from parents and money from a job. Maybe a stipend or fellowship. Now you need to fill in the blanks. On some level, you might fall into the “inconsistent income” category since you might make a pile of money in the summer then live off it the rest of the year, or supplement working part time during the year.
I wouldn’t sweat the emergency fund so much, just keep the regular stuff in line. Many of life’s “emergencies” don’t apply all that much, especially if you are living in a dorm, without a car and your parents provide some support, or you have a scholarship.
It’s a good question, though, and not as cut and dry to answer as someone with a regular income!
October 7th, 2009 at 12:27 pm
@ Alex (#37) - Cash on hand and emergency funds are not about ROI. It’s having money available RIGHT NOW if you lose your job, have a medical emergency, etc.
@ Suzanne (#31) -
Stocks aren’t the most logical vehicle for emergency funds because…well, look back at 2008.
As for retirement accounts, if you make early withdrawals, you get dinged by the tax man. Retirement accounts should be kept entirely separate from emergency funds.
Cash reserves and emergency funds should be in guaranteed accounts.
October 7th, 2009 at 1:27 pm
@66 I have money available right now, I have a small emergency fund which will cover the most likely emergency (if I need to buy a used car). Beyond that small fund, all I have to do is sell some index funds and transfer the money from my brokerage to my bank account. That would take a maximum of 3 days (One, if I wired it).
The difference between keeping that money in cash versus keeping it in index funds (assuming a $30K emergency fund) is about $9,000 over the last 6 months.
The only concern is that the market could go down leaving you with less of a “emergency fund.” The solution: save more. I have several years worth of expenses in my brokerage accounts, earning a much higher average return than if I stuck that money in cash or some CD paying squat.
October 7th, 2009 at 2:00 pm
I think the idea that you need 6 or 8 months savings is something that professional money managers (ie. wall street, Money Mmagazine) have been pushing for so long that its become a sacrosanct idea. I wouldn’t say its a pipedream but saving more than 6 months of income is vy difficult for anyone in debt or has high medical expenses. And certainly if someone is self-employed they need a healthy emerg fund. But let’s face it, if someone sets aside 10% of their take home pay (assuming 0% int for simplicity’s sake) it will take 10 months to save 1 month’s take-home. Right? And it will take 60 months to save 6 months worth of take-home pay, assuming that it doesn’t have to be tapped during that period. But most workers can survive 6 months of unemployment w/o 6 months savings because they can get a minimum of 26 weeks of unemployment insurance. It varies from state to state but usually unemployment insurance is about 60% of gross pay. People should expect to decrease their spending during unemployment. If so, they should be able to ride out six months of unemployment with about 3 months of expenses put away. I’ve seen people try to get by on unemployment or a severance package & not cut back. It can’t be done. And if someone is a middle-manager they probably won’t get severance and their unemployment will equal less than 60% of take home. So having more can’t hurt. But I wish money managers wouldn’t scare people so. There are ways to have financial security w/o a load of money but that would probably require a guest blog.
October 7th, 2009 at 2:10 pm
@Craig #53
1. I dont get the point of a cd ladder. the rates for a 6 month cd are not much better (if at all) than an online savings account. Why go thru the hassle of opening and maintaining all these cds when the money will earn the same interest in a savings account?
I have often said the same thing. J.D., can you shed light on this issue?
October 7th, 2009 at 2:18 pm
#69 @ Andrew
Laddering CDs, You start out with getting a 3 month, 6 month, 9 month and 12 month CDs. When the 3 month comes due you replace it with a 12 month CD. At the end of the quarter you still have a CD maturing in 3, 6, 9 & 12 months. When the next CD your origional 6 month matures you are replacing with a 12 month CD.
Eventually all your CDs will be 12 months but maturing each quarter.
You can do this with biannually or quarterly or whatever time break you want to do.
October 7th, 2009 at 2:31 pm
I don’t actually ladder CDs myself, but I’ve thought about it. I think the concept is sound. Once you set up the ladder, it doesn’t have to be a hassle.
I actually like Nickel’s method for an emergency fund. He puts all his money into non-laddered five-year CDs. If his emergency fund is $10,000, for example, he might have five CDs of $2,000 each. All the same length.
Then if an emergency arises, he can break into as many CDs as he needs. Yes, he pays penalties to do so, but only on the CDs he breaks. This allows him to earn a higher yield (in theory, anyhow) than with a savings account, but he doesn’t have all his money at risk.
October 7th, 2009 at 2:59 pm
The reason that the “omg, I just lost my job” part of my efund is in laddered CDs is that part is totally ‘hands off’. CDs = do not touch. It’s totally a psychological thing and I’ll admit it. I roll them over, so I’m gradually moving from 6 months expenses to 6 months of income.
I have savings/checking accounts (high yield type = about 4% now) for my ’spendable’ funds, which includes about $5K for the ‘roof, transmission, emergency room, vet surgery’ type of efund. And also starting the ’saving up for the next car and the next house upgrade’ funds.
I like segregating each purposed fund - at least on a spreadsheet that allocates a given account between the line items that I’m saving in it. Then I can gladly go out and spend the vacation fund down to zero on a trip and still feel ‘on track’ for the house upgrade fund. It’s like you play on yourself to get to your financial goals - LOL
October 7th, 2009 at 3:14 pm
what i get confused/concerned about with most of the posts here at GRS is that most of the advice, like this most recent post, is based on the assumption that you are making a considerable income ($40k) or more a year. for guys like me that struggle an entire calendar year to save a $1000 and do not have things like health insurance or even a new pair of shoes, even the best advice here is still a daunting task. for instance, i have been following the debt snowball idea but it hasn’t gone anywhere for my 20k of unsecured debt because in the year that since i have read it, i am still struggling to build an emergency fund, which will be gone again by march due to my weather-dependent job. so i spend the whole year saving to live and working as hard as i can only to have to have the money i’ve saved pay my bills in january and february. i have a second job and i’m still getting nowhere. can we get some advice on destroying your credit and just walking on your debts and being a cash-only person? i’m not interested in buying a house or a car because at the pace i am on paying things dutifully, i’ll be 40 something with little or no energy to go in new productive directions with my life when i am debt free. let’s hope i don’t hurt myself or my auto with 250,000 miles on it blows out. i think i need more drastic measures than fiscal responsibility. how about some advice on settling debts for pennies on the dollar? every post if find here or elsewhere deals with preserving your credit. why in the world would i want to do that with the shape that i am in?
sorry for the rant mate, i really love the blog. its been a comfort for me. but i need some advice for the poorer folks like me that aren’t even getting off the launch pad with the basic tools. i am starting at the very bottom of it. i know that i am supposed to ‘get rich slowly’ but honestly i’m living on borrowed time, i’m getting older, and have less energy now to make money than i did 5 years ago.
October 7th, 2009 at 3:22 pm
Ladder CD’s is pretty good and I have used them off and on depending on circumstances unfolding in my life. One point with CD’s at a bank - we all know if you cash the CD in before it’s maturity - you can lose all the interest it earned.
So,….. instead - call your friendly stock broker and buy CD’s in a brokerage account. You can ladder them the same way, one thing though - if you need to break them, the broker can often sell them to another customer without you losing the interest up to that date. Generally there is no fee to purchase the CD’s and you can shop from a much bigger group of banks. Lastly - no separate accounts - can all be linked together to keep the paperwork down.
PS - by the way - whatever method you choose to make up your fund - i.e. 2 months, 10% - first and foremost - DO IT! I have a six month reserve outside of savings for special things and retirement. It didn’t happen overnight. I don’t remember how long but my guess is that it took over six or seven years and each year, I adjust it as my circumstances change.
October 7th, 2009 at 3:30 pm
I have one week’s worth of expenses saved up….
October 7th, 2009 at 3:38 pm
@Oisbroke (#73
I hear your frustration.
Unfortunately, there are no easy answers for your situation — and many people are in it. The two things I can recommend are:
1. Patience. It takes time for these things to work.
2. Work to increase your income. If your income is low, it can be difficult to implement some of the strategies we discuss. That’s why it’s imperative that you find ways to boost income. Frugality is awesome in day-to-day life, but nothing accelerates your financial fortunes like earning more money.
How do you earn more money? Work longer hours. Get a second job. Start a small business. Sell the stuff you have. All of these work. But all of these require sacrifices, especially the sacrifice of time. Many people feel that these aren’t options for them. If that’s the case — if you’re unable to cut more and you’re unable to earn more — then there’s really no answer other than patience.
October 7th, 2009 at 4:21 pm
I think I have noodled this through.
What we are dealing with is a MINIMUM amout of cash liquidity. This can be applied to Both retirement and non-retirement accounts. Its asset diversification of having cash, and that asset’s allocation being the measure of how liquid it is.
For non-retirement savings 10% is the Minimum 40% is the Goal for very liquid savings/money market accounts. My guess is the REAL Goal is to have 100% of your gross annual salary in cash with 60% in something less liquid than a bank account like 30% CDs and 30% bonds/ bond funds.
October 7th, 2009 at 5:09 pm
@67 - Whatever works for you. I’m risk averse, so I’m okay with earning enough to beat inflation. I’m conservative with retirement investments as well, so that means I’ll only have $X MM in my retirement accounts at 55 (calculation conservatively based on current salary) instead of $XX MM, but I can live with that.
October 7th, 2009 at 5:32 pm
I’m a single and don’t have any debt. I recently pulled all my savings from ING and put it in my checking. The reason was that the interest rate is way too low and doesn’t even cover the inflation and taxes at the end. I figure it would be better to just leave it in my checking or open up a taxable investment account. Keep in mind, I have healthy 401k with 5% match from my employer, maxing my Roth, and have a very stable federal agency job doing a fairly good job - I doubt I’ll be layoff soon. It’s a rare case, but I won’t care for savings account until the rate returns what it used to be at 3%.
October 7th, 2009 at 5:56 pm
Emergency fund should start with having cash on hand, maybe $500 to $1000, preferably in small bills, should a real emergency (storm, flood, hurricane, forest fire evacuation, etc)occur. It should be kept in your house, in a safe or (thanks, Al Gore!!) a lock box (fire and waterproof). That money you can grab and go and pay whatever expenses you incur during the early stages of those types of emergencies from that cash on hand.
For long term job loss or illness type emergencies where income is lost, CD ladders, savings and checking accounts are excellent choices, because they are low risk and preserve deposit value and are extremely liquid. Your final amount for the EF may have to be adjusted from time to time as expenses change. 2000’s emergency fund level may be totally inadequate for 2009’s emergencies.
October 7th, 2009 at 6:39 pm
@Jane (#48)
Another reason not to rely on severance is bankruptcy. Up here in Canada, there is a huge tech company (Nortel) going bankrupt. They have traditionally offered a very generous severance package, however with the bankruptcy, anyone owed severance is just another unsecured creditor, at the back of the line. I believe there’s a class action lawsuit about it, but even if they win they won’t be getting the money in any sort of timely fashion.
They also underfunded the pension plan, so that’s in jeopardy too. More lawsuits there, I’m sure. It’s definitely reinforced our aggressive retirement savings (I will have a gov’t pension, but DH has no work retirement plan), because who knows what can happen? All those retired and laid-off Nortel employees were so sure that everything would be fine, because Nortel seemed invincible for decades.
October 7th, 2009 at 6:40 pm
It is an important distinction that you have made when you say that those who have incomes that typically fluctuate need a higher level of savings. It can be easy for people with fluctuating incomes to think that their income is a little more stable than it really is.
October 7th, 2009 at 6:41 pm
I have seen a variety of figures bandied about, but I was always told six months worth of expenses. I personally think that’s a little high and I usually try to have three.
I think that should be good enough to weather you thru any kind of financial storm. And if it doesn’t, it seems to me that all the extra cash in the world wouldn’t help.
October 7th, 2009 at 6:55 pm
Oisbroke:
To be quite honest, you *can* just walk on your debts. You will receive phone calls hounding you for payments, but hey, cancel your phone service, too, get a prepaid cell phone not tied to your name.
No one ever talks about this, but it can be done. People will call you. They may threaten to sue you. They wont actually sue you, because they’re really very pragmatic, and suing you is expensive, and they wont bother if they don’t think they can recover more than it’s going to cost to pay their lawyers. They really can’t collect on anything. Even if they sue you and win, then the only way they can forcibly collect from you is to go back to a judge and get him to garnish your wages, and he will only garnish some small fraction of the “disposable” portion of your income. If he determines that to be $100/month, then he may garnish $25/month to give to your creditors. I knew an attorney who found himself in this situation. He wasn’t the most highly paid attorney in the world, but even on his attorney’s salary, his wage garnishments were about $60/month.
Your creditors know this and it’s why they almost certainly wont sue you. They will keep calling you for years though, or writing you, if you tell them to stop calling (which you can).
They aren’t going to settle for pennies on the dollar until after the account’s been delinquent with no payment by you in quite some time, probably over a year.
Whether you think this is moral or not is up to you. The credit companies that loaned you the money just got a multi-billion dollar bailout from the federal government, I could see it being hard to feel bad about giving them a taste of their own medicine, so to speak, especially when it could improve your own life so dramatically.
Either way, though, J.D.s right and even out of debt, it’s going to hard to get anywhere on the salary that you’re making if you live in the US.
October 7th, 2009 at 8:00 pm
@Oisbroke, there are only two ways to improve your situation: increase your income, or lower your expenses. One big way to lower your expenses is to get rid of the debt payments. There are formulas that determine if you are bankrupt - ie if you owe as much or more as your annual income, you are bankrupt. Filing is just a step that has to happen. (I don’t know the exact formula, I’m sure you can find it online).
If your debts are not that high, then you need to service that debt and keep your head above water while you consider how you can increase your income. I know it’s easier to say than to do, but you just have to do it. I commend you for following GRS, and wish you good luck!
October 7th, 2009 at 8:02 pm
I hope that didn’t sound condescending - I’ve been very broke myself and in a deep hole so I guess I felt entitled to be direct. You might want to read Dave Ramsey’s Total Money Makeover.
October 7th, 2009 at 8:12 pm
@Dotty (#36) yes, good idea
October 7th, 2009 at 8:42 pm
Very middle class- we have had a 6 month EF for more than 15 of our 27 years of marriage. Currently we have 1/3 of all of our money in cash. Laddering CD’s is the way to go for us.Thanks for the idea.
BTW- our upper middle class brother in law just lost his six figure job. They have only two months of EF. Guess who may be helping out?
October 7th, 2009 at 8:44 pm
I saw something a while back in MONEY magazine about surviving the stock crash where one financial advisor said they tell clients to keep 2 YEARS expenses in cash.
Now, keep in mind that MONEY is aimed mostly at people making $150,000 and up, and our household maybe pulls in $80,000/year combined in gross income. So their goals are more aspirational and less realistic for us.
We have an Emergency fund, and it is about $1450. But we are steadily contributing $195 a month. We are also carrying two mortgages right now but under contract to sell our condo. Once we sell the condo, we will free up $1000 currently used for the second mortgage payment. Much of that newly available $1000 will be redirected to EF buildup.
It will take us a while to get to 2 years’ worth of cash, but I think it is a decent goal. I think we can get there by the end of 2016 or 2017. We are 34 and 33 years old.
We are driving down our expenses by eliminating cable tv (hd antenna only, no monthly cost) and switching to permanent VOIP (ooma.com) for free perpetual nationwide long distance for our landline.
But in addition to our EF, we also work on smoothing irregular payments. For example, we have a life insurance fund to which we transfer $about 95/month, but we pay about $960 for the two of us one time each year. That way there’s never a month when we suddenly have an unscheduled draw of $500+ bucks on our primary checking account.
We have “smoothing accounts” for:
Life Insurance
Auto Insurance
Car Maintenance
Charitable Giving
Travel (both our families live 250+ miles away)
Our semi-EF is our brokerage account, which has $6000 in mostly dividend-producing ETFs. If things really get bad before we build up the 2 years of cash, we can sell those in a heartbeat for some quick cash, even if the sell decision makes zero tax sense.
So this is our savings strategy. Add the EF and all spending smoother accounts, and we maybe have 1.5 months expenses once we get rid of the old mortgage.
Is it enough? No, but eventually we’ll get there. The best part about savings is if you can put some money aside and repeat that step, eventually you get somewhere. I remember when $1000 in EF seemed far away. But we’re there now.
October 7th, 2009 at 10:28 pm
The amount should be never ending, to the point where you can live off your interest income and stop working.
October 7th, 2009 at 10:40 pm
I find EF planning fascinating - it’s a mix of divination, risk tolerance, and pop psychology. Just out of school, I was a dotcommer that went through the boom/bust, and never really saw the upside of it all. When I was laid off (with severance) post-9/11 for the 2nd time in a year, I had roughly 40k in cash (around 2 yrs living expenses, also most of what I had earned). I did find work eventually, but had depleted a large portion (over 40%) of that cash before finding steady employment again.
I was unwilling to take on new debt. Many of my friends did, and it really hurt their finances over the following 3 or so years. A few were putting their EF into the markets, and their EFs were wiped out quickly.
The thought of not having cash available based on my past experience really scares me - especially in our economic conditions (I’m also really worried about inflation, the dollar, etc). Currently, I don’t keep a dedicated EF, but 3 tiers of cash (60k) based on “predicted” needs. Really Short-term: cash+online-savings, mid-long: bonds & MMF, long-term: more bonds & MMF. I do not consider this as part of my asset allocation other than “cash”, and handle it outside of regular retirement and other investments. I gain tiny interest here and there, but am not interested in rate-chasing, and can tolerate a little fluctuation in value. It’s not the best plan, but none of the current options are really very appealing.
October 7th, 2009 at 11:13 pm
I read once that a good rule of thumb for a job search time frame is to estimate one month for every $10K that you make — so if you earn $20K, estimate about 2 months, $40K 4 months etc.
Based on the volume of jobs out there at given income levels this makes a lot of sense to me, but in this economy it would probably be prudent to tack on two months to wherever your time frame lands. I might have even read that at GRS…
I agree that in many cases looking at expenses vs. income makes sense for an E.F. but I think a lot of folks low-ball this or ignore things like taxes or health insurance which automatically come out of take-home pay.
I don’t really understand keeping months and months of cash as an EF — as long as they are in safe & stable investments (CD’s, etc.). An “emergency” should justify incurring some penalty for early withdrawal — and this might be the barrier you need to distinguish between a REAL emergency and that sweet deal you saw on a new chipper/shredder.
October 7th, 2009 at 11:53 pm
i personally keep as little as i can in the savings account for personal reasons. most of what i earn is reinvested towards future financial goals
October 8th, 2009 at 1:30 am
Here in Finland, there have been articles recently about how many months people have had to wait for unemployment benefits. Because so many people have been laid off it hasn’t been uncommon having to wait for three or even four months. That’s with no income whatsoever.
With that in mind, six months worth of expenses seems like a good amount to have saved up. Even if there was some other emergency at the same time I feel I could whether the storm pretty well.
I also keep a *very* close eye on exactly where my money is going so IF I get unemployed I know exactly where I can start cutting so decrease expenses even more.
October 8th, 2009 at 1:55 am
10% of your monthly wage is what I was always told by my parents when it came to saving. I think a lot of people overlook savings, especially younger people, but it is vital to build for your future.
October 8th, 2009 at 3:07 am
I think those numbers are a good loose guideline, but I agree with Amy Dacyzcyn when she says that the problem with goal-numbers for saving money stop being goals and become savings caps. Seems to me, you optimally would want to save as much as you could, considering you spent your precious time in exchange for said money. Of course, that’s just me.
October 8th, 2009 at 4:57 am
@68, I wouldn’t want to rely on unemployment compensation, in Florida the max you can receive is $275 a week. There are some states, like PA., where the rates are higher, in the $500s per week, but most states don’t come close to replacing salary.
October 8th, 2009 at 5:10 am
@Financial Samuri & Penny: you can always save more. But at what point does more become enough? At what point does more become selfishly hoarding? “Just a little more” is an unatainable goal that yes drives us to keep going but also doesn’t allow us to live and live well.
One thing my wife and I talked about when we first got married was having caps on our savings where at a certain point we would stop adding to our savings accounts and use the money we would have saved to give away to places that needed it. That being said, we’re young, loaded with student loans, living on a starting salary income, and no where near any of those caps. But we hope to get rid of our student loans, buy a house, start a family, and balance work and life so that we can give where we see need. It seems like a long ways away at this point but we’ll take it one step at a time.
October 8th, 2009 at 6:26 am
We have about a year’s salary in liquid, something I am quite proud to have saved- about half is in a CD, and half is just regular savings (both ING). I know that the super low interest rate savings isn’t the best place for this money, but it all seems so confusing - where should I put this money, and can I put it somewhere where I can still get at it if absolutely necessary? Also, having seen my stocks plummet, I am more hesitant to put my money somewhere to lose value - at least with a teeny interest rate with ING, I’m not losing money (inflation aside). It always seems so overwhelming to me.
October 8th, 2009 at 8:37 am
@99- You are right not to swallow the Kool Aid in here telling you to keep years worth of money in cash & cds earning nothing in interest. You’re effectively losing out on thousands of dollars by listening to these folks. Also these ultra-risk averse people aren’t being as “safe” as they think they are, because earning such a crappy interest rate leaves them vulnerable if there is a period of high inflation.
Everyone is different, but here’s what I would do. I would take the money you are most likely to need for an emergency (say 1-2 months worth of expenses, or the amount needed to cover the most likely emergency) and put that money in an internet savings account or money market account. Then, I would divide the rest of the money up into bundles of non-correlated assets- which specific assets depends on your risk profile, but I have mine in a mix of domestic and international index funds. By spreading it out in multiple places, you’re getting a higher long term return on your money and minimizing (though not eliminating) your risk.
A great book on this is Gillete Edmunds, How to Retire Early and Live Well on Less than a Million Dollars. Its pretty straightforward and easy to follow, and despite the name, its actually more focused on investing.