How and why you should start an emergency fund
Most personal finance experts agree: The first thing you should do — after meeting basic needs — is to establish an emergency fund.
Life is full of unexpected surprises, many of which cost money — a thief smashes the windshield of your car, your son gets sick, your water heater overflows. When people live paycheck to paycheck without any savings, they’re at the mercy of these small crises. Sometimes a tiny problem becomes a huge one because the victim wasn’t prepared for possible trouble.
That’s where the emergency fund comes in.
What Is an Emergency Fund?
An emergency fund — or “rainy-day account” or “safe and sound money” or whatever you’d like to call it — is a chunk of change set aside specifically for the unexpected things life throws your way. It’s not to be used to buy a new car. It’s not to be used for a vacation to Paris. It’s not to be used to remodel your bathroom. It’s for use only in case of emergency: a tree falls on your house, your youngest daughter breaks her arm, you lose your job.
I have a couple of friends who believe emergency funds are unnecessary. They’re wrong. Maybe emergency funds are unnecessary if you’re rich. But these friends aren’t rich. For most people, emergency funds are a form of self-insurance. They’re a proactive way of protecting you and your family from random crappy events.
How Much to Save in an Emergency Fund
Though personal finance experts agree emergency funds are necessary, there’s no consensus on how much is enough. Here are just a few recommendations:
- In The Wealthy Barber, David Chilton argues that it’s best to have adequate insurance to cover the big emergencies, and to set aside between $2000 and $3000 to cover small crises and the things that insurance won’t cover.
- In The Six-Day Financial Makeover, Robert Pagliarini writes: “Your emergency reserve is your financial cushion in case something goes wrong and you lose your job or you need access to money quickly. Your emergency reserve should consist of at least three months’ worth of cash. Once you’ve saved enough for the cushion, you can [move on] to other goals.”
- In You Don’t Have to Be Rich, Jean Chatzky recommends three to six months of living expenses.
- In Your Money or Your Life, Joe Dominguez and Vicki Robin recommend six months of living expenses — but only once you’ve achieved financial independence. Before that, they want you to put your money toward debt reduction and wealth building.
- In The Total Money Makeover, Dave Ramsey recommends a two-stage approach. First, before anything else, set aside $1000 to cover emergencies. Then, after you get out of debt, boost you emergency fund to cover 3-6 months of living expenses.
My own advice is to do what works for you.
Start small. If you don’t currently have a rainy-day fund, then anything is better than nothing. Set aside $500. Or $100. Or $20. Over time, work to build this buffer until you have $1000 or $5000 on hand for catastrophe. Ultimately, you’ll sleep more soundly if you do have six to twelve months of living expenses in the bank. It’s a comfort to know that if you lose your job, you won’t lose your home right away.
How to Start an Emergency Fund
Starting an emergency fund is totally non-difficult. Anyone can do it. Here’s how:
- Pick a bank. I’m a fan of local credit unions and community banks, but I also like high-yield savings accounts at online banks. (My emergency fund is at Capital One 360, although there are plenty of other options.)
- Build a buffer. If you’re still in debt, it’s probably best not to stick a lot in savings. You should set aside $500 or $1000 to deal with annoying emergencies like a car that breaks down, but the rest of your money should be thrown at your debt.
- Resist temptation. When you have a big chunk of change sitting in the bank unused, it can be tempting to use it for other things. Resist the urge. Use your emergency fund only for emergencies, otherwise you defeat the purpose.
- Save more. As your debt dwindles, and as you get better control of your finances, build your emergency fund. Pick a number that helps you sleep at night. For me, that number was $10,000. That seemed like a lot of money to me (and still does!), and if anything disastrous happened, it would help me survive for a long time.
Finally, it’s wise to keep your emergency money someplace that’s not too easy to access. (Ignore this piece of advice if you know you’re disciplined enough not to use the money for other purposes.)
You might, for example, open an account at a bank across town. Or deposit the money with an internet bank. Or put the money into a certificate of deposit. Don’t carry a debit card tied to your emergency fund. You’ll still have access to the cash when you need it, but you’ll be forced to consider your actions before making a withdrawal.
When Is It Okay to Use Your Emergency Fund?
But what is an emergency? This is an interesting question, and one I’ve thought about a lot lately. How do you decide what is and what is not an emergency?
Sometimes the answers are easy, of course. A vacation to Florida is not an emergency and should not be funded from your emergency fund. New boots are not an emergency, and neither is a new videogame console. On the other hand, if your only car is totaled, buying new transportation is an emergency. Or if your son breaks his leg, his medical expenses are an emergency.
But what about all the stuff in between? What if your computer dies? Is that an emergency? Or should you just go to the internet cafe? What if the garage roof starts to leak? What if you have an unexpected dental bill?
Ultimately, I think the key is to decide for yourself what you emergency fund can be used for and what it can’t. But once you make that decision, stick to it.
Final Thoughts
From experience, I know that it can sometimes be painful to see a large pool of money sitting unused for months (or years) on end. But also from experience, I know that when a natural disaster strikes (or any other kind of disaster, for that matter), an emergency fund goes a long way to preventing financial disaster as well.
Studies show that those without emergency savings are more likely to accumulate debt. Your emergency fund acts as self-insurance, cushioning you from small disasters. If you have a cash cushion, your financial plans can’t be derailed by a single unexpected event — unless it’s huge.
How much do you keep in your emergency fund? How did you choose this amount?
[photo by Incase]
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There are 215 comments to "How and why you should start an emergency fund".
The goal for my emergency fund is one year’s worth of expenses. You can’t underestimate the importance of cash. Not only are you secure financially, but the peace of mind and the confidence you gain are invaluable.
I’m not a fan of tapping home equity as an emergency fund. It also just doesn’t make sense. Put your emergency fund in a money market at anywhere around 4-5%. This is about what you’d save by paying your mortgage down since the interest there is tax deductible. Also, your home is not a savings or investment vehicle. It’s part of your living expenses. Don’t confuse this.
Nice blog.
-limeade
http://fiscalmusings.blogspot.com
I think that the amount of an ’emergency fund’ is highly dependent on your risk tolerance and job stability.
If you’re in a stable job with excellent disability benefits, the chances of your income suddenly vanishing are extremely small. In this circumstance, using a line of credit as an emergency fund can be a good idea, since you’re confident you’ll have the income to pay down what’s borrowed.
If your job is less stable, or is more dangerous, you may want to have more cash on hand, in case you suddenly lose your income due to an injury or illness.
Personally, I think having a few thousand dollars readily available for emergencies is the minimum, but it’s probably unrealistic to have a full year’s salary available “just in case”.
We are shooting for $1000, then we will lower the monthly contribution and apply more to outstanding student loan debt.
It all depends what constitutes an emergency. After a natural disaster lenders may freeze or revoke a HELOC if they have reason to believe the asset backing the mortgage is devalued from the event.
My e-fund is for 1500 a month (covers cobra plus normal expenses) for 12 months and thus is 18,000 dollars cash (errr, well in a money market fund).
Probably too large but it is what I keep. Mind you I have agressive investments also so this helps balance out some risk my portfolio.
What kind of banker would give a home equity loan to someone who had no job? I don’t think I would want that risk.
All this “how big an emergency fund”, “pay off your debt” stuff gives me a headache. I can’t figure it out. I’m not an accountant or investment guy. I’m a programmer. Soooooo I program and when it comes to finance I play stupid. To cover myself, and my stupididty, I don’t have any credit card debt. I have two car payments and a mortgage payment. I put 10% of my salary in a 401k. And I have an emergency fund with close to $50k. I feel these moves keep me covered until I can learn more about investing and all the stuff that goes with it.
There is no one size fits all answer to this, and this is why there is such a wide range of recommended amounts. Most financial planners are taught that 3 months of reserves (6 months for a one-income household) is as a rule of thumb. The purpose should be to have cash available to cover short term costs, like waiting for the insurance company or while you look for a new job. If you are under insured (or self insure) you may want more. Home equity serves as a nice backup to a cash reserve should you deplete the whole reserve or temporary access part for a non-emergency. This strategy may be a nice compromise between an a large cash reserve and relying solely on a home equity line of credit.
Here is any easy (maybe even fun) way to “crash test” your finances. Make a copy of your Quicken, Money, Excel worksheet, or grab a blank check book register and simulate emergencies. Try injuries, illness, job loss, car gets stolen, day care evaporates, part of your house requires repairs, legal fees to mount a defense, whatever you can think of. You may need to do a little research, but this can help give you a sense of what your cash flow needs might actually be so you can plan accordingly.
I have pondered over this question for a very long time. I am single and rent an apartment. Although I have a lot of money invested in my 403B, I do not have much saved for an emergency. When I do have a few thousand saved, something comes up such as car repair, or my computer crashes and I need to use that money that was intended to be used in case I lose my job. This shows me that I need to save more than just a few thousand dollars. I think we all need to think of the unexpected expenses that can pop up on top of our monthly bills because believe me, that money goes fast!
My wife and I just sat down this past weekend to go over this question. With our first kid on the way now and us dependant upon my salary alone, we decided that having 5 months living expenses would be a nice cushion in case things go bad.
We keep that money in an money market savings account so we can quickly access it if need be. We also have no other debts except for the house note.
I agree with what most people are saying in that there is no single hard and fast rule here and it’s up to individual situations and risk tolerances.
Personally, I don’t think I need a lot in an emergency fund, for a few reasons: I’m in a profession that lends itself easily to self-employment or work as a contractor, so if I lose my salaried position I could still find enough work to pay the bills fairly easily. Also, my necessary bills are relatively low–my mortgage payment is less than 10% of my gross monthly income, and I don’t have a car. My other big bill is my student loan payment, and I could get a forbearance if I absolutely had to.
There are always other ways to scrape up cash, and credit cards are a viable short-term option for groceries and utilities. In short, while I like to have a few thousand dollars in cash just in case, I think that would suffice for me if anything happened. A year’s salary sounds absolutely insane, and even six months’ expenses seems unnecessary.
You friend’s advice about the HELOC makes perfect sense analytically. However, money isn’t just an issue of mathematics. Money is emotional.
Having a few months expenses sitting in a local bank conributes heavily to one’s peace of mind. Having to borrow funds when your car breaks down or you roof gets a leak only adds stress to the already stressful situation.
In addition, since it is so easy to borrow money from a credit card or HELOC, one’s definition of “emergency” tends to grow rather fluid over time. If you ever want to reach your financial goals, you have to get out of the vicious cycle of borrowing and paying back creditors.
As many others have already said, the exact amount of an emergency fund will vary depending on your needs. In our case, we’ve saved about two months’ expenses so far, but our goal is six months’.
I don’t know. I have always wondered what is considered an “emergency”?
Is it limited to things like losing a job and needing to pay for regular expenses? Car breaking down- is that an emergency ( I just pay stuff like that out of regular expenses)?
Someone broke my car window a couple days ago and stole my CD player and some other things- is that an emergency? Again, something I will probably just pay out of regular funds that I don’t consider an emergency fund. Maybe since I live below my means I have a perpetual emergency fund that isn’t designated as such.
If I had a large emergency fund, I don’t think I would ever be in a position to need to touch it. An emergency would have to be something pretty catastrophic. I would have a difficult time deciding to use it.
I also keep my expenses low enough that I could get by with any menial job, pretty much. I mean if I had to I could find something to do within a couple weeks or a month at any time. maybe not something I really want to do, but something to cover house, food, utilities- the basics. I could cut off my cable, cable internet, cell phone,etc if I really HAD to.
I think this all depends on a combination of things such as salary/lifestyle expenses, insurance level, number of dependents, etc.
Andrea’s classmate’s advice leads me back to a thought I’ve had for a little while now (and it’s not an original thought). The people with the greatest ability to fund a large emergency fund are the people least likely to need it.
For example, someone who is financially responsible and pays off their credit card each month typically has a large available card balance. If disaster hit, even if this person has no emergency fund, they have the card to function as one (albeit an expensive one). Someone who does not pay off their card each month typically won’t have an emergency fund either. The only difference is this second person probably won’t have the available credit to pay for an emergency.
I strongly recommend NOT using your home equity line for an emergency fund. Going into more debt is not a great way to deal with an emergency. Relying on a HELOC for emergencies fosters an attitude of lax financial planning rather than a proactive, controlled approach.
It’s vital to start with at least a small emergency fund ($1,000 is a good recommendation) to get you through the minor emergencies. As you pay off your consumer debt, you can then use the funds that were going towards debt to build a more substantial emergency fund. 3 to 6 months feels about right to me (I think we’re currently at 3-4 right now).
I agree that there’s no magical amount. Even if you decide on 3 months of expenses, there’s still a lot of variability. Will you save 3 months of bare-bones expenses? Or 3 months of expenses with your current fully-employed lifestyle? I recommend going through a few emergency scenarios (losing a job, etc) and imagine how you would live. What expenses would you eliminate? Would you eat out? Then plan on saving enough to meet those types of expenses. If you don’t plan on changing your lifestyle in case of an emergency, you might want to save a little more.
There’s no need to get too technical when determining how much to save because it’s still really squishy. And just remember that any emergency fund no matter how small can provide substantial help and security. As it grows it just provides even more.
I agree that on paper the HELOC idea has merit, but from a practical standpoint I don’t think it should be the primary emergency fund. I think it would make a better emergency emergency fund.
That said, most of my emergency fund is invested. I have some cash, but the likelihood of having an immediate need for 6-12 months worth of cash is pretty slim. I can divest my holdings as necessary and have cash within 3 days, which should be good enough.
I’m going to agree with several others here that emergency reserves are often overdone. Now, I’m really talking EMERGENCY reserves — a dead car and the need for a new one is not in the same category of a lost job or disability. If you consider a need to make a sudden purchase such a car, refrigerator or replacement TV an emergency then you need more short term reserves.
Otherwise, you should simply keep a portion of your savings in non-retirement investments (so that you don’t get a heavy tax penalty for withdrawals on them). Yes, they’ll grow more slowly than tax-advantaged retirement accounts, but they can be accessed in a few days to a week or so at most. If you have funds like that, you can use credit cards while liquidating assets, then pay them off immediately upon receipt of your money so that you pay no interest.
If you really want to avoid credit cards entirely, just keep a week or two’s worth of cash in a savings or money market account.
If you DO wish to treat a home equity line as a source of emergency funds, make sure you establish the line of credit BEFORE an emergency arises. You want to be able to write a check on that account immediately — and your bank might not like to offer you such a line of credit if you are already in an emergency situation.
Taking out a home equity loan when you become unemployed is not a good idea. You risk becoming both unemployed and homeless. Whether you call it an “emergency fund” or just “liquid investments” doesn’t matter, and there is no maximum amount.
Also emergencies are not just unemployment. They include medical emergiencies, natural disasters, etc.
I dont believe racking up your credit cards is a good idea either as some of the previous enteries have stated.
Home equity credit is DEBT, not “pulling money out”. You “pull money out” of a home ONLY when you sell it. Home equity lines of credit are a form of BORROWING money that MUST BE PAID BACK WITH INTEREST.
As long as that is clear, you can make an informed decision about emergency funds.
I bet the MBA who wrote that home equity credit is “pulling money out” probably lives hand-to-mouth on a six figure salary… little net worth. Most of the MBAs I know are miserable managers of their own money.
First, define “emergency”. Is it a car breaking down needing a repair that you had not anticipated? Then emergency funds of $1000 – $2000 might suffice.
If you define an emergency as “a job layoff with little or no serverance pay from a job that is highly specialized and not easily portable”, then 6 months or a year of salary might be in the ballpark of “enough”. That is how I define an emergency, from personal experience.
If you have other fairly liquid assets, such as stocks, you don’t need as much cash in an an emergency fund. The odds of a long stretch of unemployment coinciding with a significant loss of value of a well-diversified stock/mutual fund portfolio are small (though still possible). So count your taxable brokerage account assets.
In a real pinch, you can also tap tax-deferred retirement plans such withdrawing IRA funds early (with penalties and taxes) and borrowing from your 401(k) accounts, but those should be a last resort because of the damage those actions cause to your long-term plans and you get only a short-term benefit (funds until the emergency is over).
I have 6 months net income in an emergency fund, but its in staggered high-yield CD’s (about 5%APY, 8-12 month terms). I earn interest, and money is always available if I need it.
I think HELOC is a bad idea, i dont like paying interest…good budgeting should mean you dont have to deal with it
It is very much a personal decision in regards to risk and circumstances. I think having enough so that you can sleep at night and not have to sell investments or sell a home is realistic. Also, personally I keep less due to the fact that both my wife and I work, whereas if we were dependent on one job I would want a larger emergency fund. We are generally aggressive investors and likewise aggressive with our money and do not have too large of an emergency fund (~10k) but then again we have no credit card debt or mortgage payment that we are locked into.
-Thor
What about sick days and vacation days. Does anyone consider that part of your emergency fund?
If you always have two extra weeks of leave isn’t that at least half a months worth of emergency money.
Then if you get paid two weeks behind your actual work days thats another half month of emergency cashflow. Your up to a whole month.
This is one I struggle with, not so much from an “emergency” standpoint, but a “just living” standpoint. I’m not currently working and don’t expect to work again for quite some time. The challenge is trying to figure out how much I should simply have in cash vs. invested. 6 months of expenses? A year? I know that I’ll have to liquidate some of my investments as I go along no matter what, but how much to keep in cash for the time being is the challenge.
Tapping a HELOC during an emergency? Isn’t that akin to putting gasoline on a fire?
If it’s an emergency, then things are stressful. Piling on debt in the form of a HELOC will only make things worse.
Having a few months in a short term account is all you usually need while you figure things out.
Other money can be put into stocks,MFs, ETFs, instead of an MMF(MMFs only gain 4-5% a year) and tapped as need be after that hypothetical first 3 months.
The concept of having an “emergency” fund is a good one. While it is typically cast as being a liquid investment that covers X months of expenses, I think that definition is a bit narrow and that the vehicles one uses to create a cushion for such an emergency should be more flexible and (as suggested), align to each person’s individual situation.
For example, when I was early in my career my main focus was on maximizing savings to cap out on my 401(k), etc. Emergency savings were not a high priority for me because:
A) Expenses were relatively low and entry-level jobs were plentiful
B) I didn’t feel like I could “waste” money in a cash account while not maximizing my other investments like 401(k), etc.
C) My parents
As I grew in my career and got a family, house, etc, the ability to weather an emergency more of a priority:
A) Income harder / takes longer to replace
B) Increased financial responsibilities
C) Responsible not only for yourself, but others
However, as I am still not capping out on both my 401(k) AND Roth IRA, I still feel there is some trade-off. Therefore, I do not specifically have cash set aside for an emergency, HOWEVER, in case of emergency, I can:
1) Access revolving credit
2) Access home equity
3) Access retirement savings (loan)
4) Access other loans
Granted, that is not to say these options are “optimal”, etc. For example, many would say you shouldn’t tap your retirement accounts. Generally, I agree. However, the total dollars you have available to you are the same. Whether I invested $100 only my retirement account or split it $50/$50 between there and an “emergency fund”, the total is still $100. Arguably, which account(s) the $100 sits in is thus less relevant.
Don’t get me wrong, you have to weigh your options and consider the potential consequences (ex: a 401(k) loan where you pay yourself back is much better than a distribution where you pay taxes and are penalized).
My point is that we are talking about an emergency (which are hopefully rare) and there are a number of “emergency” options available…not just the cash one.
Generally speaking, I think you should be absolutely focused on maximizing wealth and making full use of tax-advantaged vehicles to do so. If those are maxed out, then perhaps you can think a bit more about having more ready cash available, etc.
Until then, I might offer the other emergency options I listed as viable (and for me, preferable) alternatives.
I would say it depends on your risk tolerances and what you feel comfortable with.
I have an emergency fund, but have never thought about how much it should be. I have an UK tax free account, ISA, which I put the maximum allowed in for two years which now gives me over 3 months salary.
I stopped putting money into my ISA account once we got an offset mortgage. Most of the spare cash goes into the offset to reduce the interest on our mortgage, however we can still access the money so can take money out if we need to, so I guess it works like an emergency fund as well.
I have a multi-step emergency fund. The first step is about $1000 in an ordinary savings account. It is low interest, but I can get to it quickly. I then have about three months savings in a money market account. Better interest and it takes a couple of days transfer the funds back to my checking account. Any savings on top of that goes in longer term investments that make more than the money market account. I also make sure that my credit cards balances are low.
I think there are two levels to emergency funds — the first being if your car needs a big repair or your heater/washer blows up, or (heaven forbid) you need a lawyer for some awful reason).
The other reason — what I like to call the “contingency fund” is to cover sudden income loss. Having been laid off with NO contingency fund and no severance pay, I think it’s really important to have at least a few months of LIQUID savings here — preferably more. My minimum comfort level here is 6 months. In addition I’d like another 6 months in something short term CDs or Bonds, something ultrasafe but hopefully earning a little more interest.
There’s no way in hell I’d rely on a HELOC as my emergency funds. When your emergency is over, at best now you have a debt to pay.
db
Great article & lots of interesting comments. My own $0.02 are that while it may not make the most cents economically (pun intended!), having a 3-6 month emergency cash reserve in savings / CDs / money-market funds buys you significant peace-of-mind. My goal is to have 6 months of cash (savings/CDs/mmf) at my current lifestyle saved up. The anecdotes I have heard are that having that cash cushion will really make you feel free — give you options to quit your job if it gets too bad, or recover from a medical expense or unemployment or serious car problem. Keep maybe a month’s worth liquid, put the rest into a CD ladder to earn higher rates.
I don’t like the idea of using HELOCs, credit cards, or investments (stocks/mutual funds/etfs) as my “emergency fund” because those all have strings attached. HELOCs and credits cards you have to pay back with interest, so as soon as you have your emergency, the clock starts ticking and that’s just additional stress that you really don’t need. With investments, the big risk there is that your emergency comes at a time that’s not convenient to Mr. Market. What if your emergency need happened on 2/26? Over the next 2 weeks, the market had dropped between 4-6%, some stocks much more. And if we run into a serious bear market like some warn (or like we had in 2001), your e-fund will shrink even further. Diversification will help reduce the risk, but not eliminate it. The money I invest is money I don’t intend to need for at least years, if not decades. Selling off investments should be done carefully & rationally, since it can have a serious effect on your long-term wealth and your short-term tax consequences. In an emergency situation where I need cash, I would not want to be forced to make such decisions since I will not be thinking rationally with a long-term focus.
And of course, you need to decide what “emergency” means to you. And it’s probably more like a spectrum — ie unexpected job loss is an emergency right now. Car that is aging and will need replacement is something to start planning for so it doesn’t become an emergency. House flooding or major appliance dying — more things that may require an emergency fund withdrawal.
i have built ALMOST a year’s worth of emergency funds.. i have no mortgage, therefore a HELOC would be out of the question for me
you can never have TOO MUCH saved for a rainy day.. i have it setup where i can easily take cash out for a necessity
checking (for everyday stuff)
then regular savings (my checking acct’s backup plan)
then ing direct (emergency funds)
then roth ira (last option.. can take out contributions if really needed)
it’s nice to have that freedom to know that if i wanted to quit my job and relax for six months comfortably, i could
Just a note for taking out a loan on a 401(k) — I’m opposed to it, especially in an emergency. And there’s no point in planning on it as a fallback. When I was laid off they wouldn’t let me take a loan out of my 401(k) — I either had to roll it all over or I had to withdraw it all.
Of course, since I had NO EMERGENCY FUND, I had to withdraw it all. By the time taxes and penalties were taken out and I was re-employed, my entire retirement savings was now also gone. THEN to add insult to injury, two years later the IRS audited me for that year I was laid off and demanded an additional $1000+ penalty (including accrued interest of course) for a math error that resulted in me getting too much distribution and not enough penalty the first time around.
Retirement savings should NOT be the plan for emergencies. Just please don’t plan that way — using retirement funds this way is because of a failure to really plan.
This is a very good debate. Just a few points to add.
1) I define an emergency as something that causes significant but temporary hardship on your normal cash flow arising from medical problems or job loss. Basically I can always afford the emergency in the long run, but I just don’t have all the cash right now.
2) It is ok to use a line of credit to help the cash flow out as long as you know and can handle that risk. I hate to have $10,000 just sitting anywhere in low interest when I can pay down my house (Note: I’m in Canada where we can’t deduct our mortgage interest).
I’ve personally been through a medical emergency with our first child and after 2.5 months in the hospital and over $15,000 in extra expenses we used a line of credit to help cover it for the short term. In less than one year we had it all paid off. I know that is a risk in using credit this way, but I would gladly do it again because it works for me.
CD
I think emergency funds for many people are way overrated. If your finances are fairly healthy (and you’ll know if they are), I think it makes sense to keep a very small emergency fund in cash, and then use credit cards for your real “emergency fund”.
By definition, a true emergency should be rare. And for those rare occasions, it makes no sense to have a big stash of cash sitting around when you have easy access to credit.
My emergency fund is about three months expenses and is also (like Kate Davis) in an ISA. I use my credit cards as an emergency emergency fund. I wouldn’t like to use anything like a HELOC as the risk of losing my home would cause severe insomnia.
My goal for my emergency fund is approximately 5 months expenses, which would cover living expenses and say the boiler breaking at the same time.
See, I don’t have a problem using a HELOC as an emergency fund. If it was a major emergency (job loss), I would be forced to leave the country because of my immigration status. Therefore, I would sell the house. I have the HELOC open now, so I would just pull the money, pay the movers, and run. Since I have over 20% equity in the house, and the HELOC represents about 5% of equity (at today’s market value) I don’t think this is a terribly risky scenario. The proceeds from the sale of the house would cover the HELOC and I’d have enough cash to tide me over.
At that point, we also have the family as a back-up strategy. My husband’s parents are rather well off and have a large house where we could crash until recovered.
I do have liquid cash for breakdowns, repairs, new cars, etc. I don’t consider those emergencies though.
@samerkand —
Here’s where I stand on relying on credit for emergencies. I’ve spent the last 2 1/2 years of my life sacrificing big time to PAY OFF my credit cards, more than half of which represents charges during an emergency layoff to survive. I’ve got another $10K to go. The last thing I’ll ever want to do again is rely on credit cards in that sort of cash flow emergency.
So — an 8 month layoff cost me thousands on credit cards and wiped out my entire retirement. Failure to be prepared, I counted on credit and retirement as my “plan” in the past. Please don’t make that mistake too.
db
To me, emergency money would be for anything that would normal require going to the insurance company.
I myself don’t like the idea of insurance, I’d much rather have an emergency fund that could handle most everything. Especially smaller items.
The more money that is in my emergency fund the less insurance I would need from insurance companies.
samewriter.. using credit for those rare emergencies might be a good idea for those who have thier financial situation under control
BUT we’ve already seen what credit cards do to people who can’t control their spending.. i just don’t see that as good advice
$15K. That’s six months of living expenses. No reason why we have that amount. We don’t own a home though so HELOC is obviously out of the question.
I tend to lean towards pumping it back into your mortgage (after ensuring a basic fund that can handle most emergencies). Keep in mind that an emergency can happen at any time, but the corollary to that is that an emergency MAY NOT (AND LIKELY WON’T) HAPPEN AT ALL. If some big emergency does come up beyond your basic fund, your money is still there in your equity, you just have to fill out paperwork to get it. And as a bonus you won’t be (as) tempted to dig into the money to go on vacation to Hawaii
But what if some big emergency doesn’t come up? Then you end up paying your house off early, and all things being equal, that means that no matter what, you will generally always have a roof over your head.
I keep six months of reserves in a money market account and find this adequate for my families security. I do like clients to have HELOC’s avaiable for opportunities like a great investment or short-term major housing expenses. Using a credit line for weathering a set back is bad advice as this would increase your monthly obligations as you increased the balance. That being said if a credit line is the best you can do because your are incapable of saving money then use it sparingly. The challenge you may have is if you cannot save moeny then having access to your equity could be reckless as you may decide to buy a new car or take a trip etc…
Build reserves and build your sense of freedom.
Cheers,
Bryant Keefe
Well, I don’t have a house… but I do have an emergency fund! I was able to get it over $1000 in about 5 months by putting 12% of my monthly net income into it. Now I plan on cutting back on that just a little bit and putting more towards paying down debt, one bill at a time. 🙂
Thanks, everyone. I’m not sure my point / my classmate’s point came through here. Instead of having, $30k in an emergency fund, you throw that money (in one chunk) at your mortgage. If an emergency happens (which I pretty much only count as unemployment), you pull that same $30k back out. It’s debt that would have existed if you had the emergency money liquid somewhere else.
For example, you have a home worth $500k. You owe $330k on your mortgage. Instead of having $30k in an emergency fund, you put $30k against your mortgage, bringing it to $300k. You keep your mortgage payments the same. If an emergency (e.g. unemployment) comes up, you pull the $30k back out. You are in no more debt than you would have been if that money was sitting in a bank account. In fact, you’ve instead been avoiding 6% interest and putting more toward the principal, so you’re ahead.
The key here is that this money has been put down on your mortgage. It’s not just a home equity loan — it’s a loan that pulls out the money you put in for this purpose.
I should note that I live in Canada, where mortgage interest is not deductible. Also, we have unemployment insurance for a year, here.
I would never pull this money out for anything else. I do not consider roof repairs, car repairs or the like to be emergencies. I instead have a bank account with money set aside for these purposes. And I always have enough in the bank to pay my credit card in full every month. (I basically just use the CC as a convenient interest-free 3-week loan that gives me 2% back on everything.)
I don’t have a high ratio mortgage. Even if the local housing market drops 25%, I will still be ahead on my mortgage (and still have room to pull out that emergency fund).
I’m not worried about being approved for a HELOC — I’ve already got one that’s about 1/2 of our annual household income. The balance on that and everything except the mortgage is $0.
I just wanted to weigh in with these points, in case they change anyone’s suggestions. I would have been here sooner, but it didn’t work out. 🙂
I had been claiming that it’s far better to use a Home Equity Line of Credit for almost a year now. I think Samerwriter had it right, “By definition, a true emergency should be rare. And for those rare occasions, it makes no sense to have a big stash of cash sitting around when you have easy access to credit.” Basically you are losing thousands and thousands in opportunity cost by not having this money optimally invested.
They don’t change my suggestions. I think, frankly, that it’s a stupid idea to do this with a HELOC. If you ever pull it out, you’ll be subject to interest and you’ll have to pay it back.
Wouldn’t it be better to just have the cash sitting and ready for you? If you deplete it, you’ll have to build it back up again but there won’t be any interest.
I’m coming from the perspective of losing a job too — if you lose a job you want to be able to be as liquid as possible. Including being able to sell the house if you need to. And given the volatility in the job market, I think its foolish to assume a layoff won’t happen to you.
If you are going to pursue the HELOC idea, at least keep a portion of cash reserves — at least $5K or so. That way hopefully you won’t have to do the lunatic maneuver of tapping a HELOC because you need groceries and an interview suit.
I feel strongly about this because I’ve been through a layoff using stupid money. (and I don’t have a house now, partly because I’ve been through a layoff using stupid money)
db
Well, we’re a two-income family, so there’s always someone to buy groceries and clothes.
Yes, there’s interest on a HELOC. But if you go, say, four years with continuous employment and then take out a HELOC and have to pay it back over four years, isn’t this the same as the four years of foregone mortgage interest?
And, if you have, say $200k equity in your house and you take out a HELOC for $30k, your equity is $170k. This is the same equity as if you had never paid down the mortgage with $30k in the meantime and you are still paying interest — over 20 or 25 years. So it shouldn’t keep you from selling your home.
In my way of thinking, $10K in the bank earning some amount of interest is appropriate for an emergency fund. A CD or Bond is less desireable but ok. A HELOC is not. Why? Equity should not be used as a savings account or a line of credit. Period. I simply object to it.
IMHO, the reason the real estate market in the US is in trouble right now is partly because people take inappropriate liberties with their equity.
I ask again, if the idea of your mortgage sitting there is so onerous, why not keep $5K or $10K in cash, and pay the rest on the mortgage, so that if an emergency happens you have the cash and don’t have to do funny things with your equity.
A house is NOT a savings account.
db
P.S. We have unemployment insurance in the states too, and I used it while unemployed. I got the maximum payment allowed, and it didn’t even make my rent payment. (I’d also exhausted my benefit before I got a new job.)
It’s great that you are a two income family — if you’re a consultant you’re probably not that far from having the ability to get a contract. Not everybody is in that position. I wasn’t, and though I’m very employable (great resume, mid-career, pertinent masters) I was laid off because the industry I’m in (IT) was in a downturn. So I had to ride out 8 months of no income.
I’m a renter, and my available credit lines only total $1,300, so using credit as an “emergency fund” is totally out of the questio for me. I currently have about 7.5 months of my take-home pay sitting in cash in a designated emergency fund. It would last me significantly longer if I were in hardship situation and living a truly bare-bones lifestyle. I’m in my mid-twenties, living in a very fluid rental market, in a very fluid time of my life job-wise, so the extra peace of mind is great.
Many consider unemployment as an emergency, and I do as well, but what about a medical situation where you can’t work? I know of a young lady who was diagnosed with cancer. Many days away from work and many treatments later, she seems to be back on the mend. Her insurance would only cover a portion of her treatments, and she didn’t have any income for the weeks she was out of work. I call that an emergency! To consider using equity as “insurance” is crazy!
I’m in a two-income family, too. Maybe I’ve got a morbid imagination, but believe you me I can come up with some nightmarish scenarios where in short order neither of us are pulling in an income, at least temporarily.
If I were, heaven forbid, on leave from my job because I was constantly at the bedside of my terminally ill husband or child, there is NO WAY I’d be willing or able to handle home equity gymnastics in order to keep the lights and heat on at home.
We have never had crushing job loss or major upheaval from a natural disaster, for which I am grateful. But I have had a taste of life-threatening emergency for one of my kids (thankfully it ultimately turned out to be easily remediable, and not a long-term problem), and it put our whole lives in a tailspin.
One of the reasons why you have an emergency fund in a place where it’s easy to retrieve if you need it is because if and when that emergency materializes, you may not have the energy and emotional reserves to deal with something more complicated.
For the record, our emergency funds (half in savings, half in laddered CDs) is enough for about 3 mortgage payments, or about 2 months of all living expenses. I’m aiming for 6 months but think it’ll take a year or two to get there.
It’s funny that you post this question as I was only just having this discussion with a friend. He believed that the money I have just started putting away each week for an emergency fund ($20) would be better put into my mortgage. I disagreed with him and said that for me the process of seperating some money out into another account for one purpose was much easier to manage and also gave me a greater sense of being in control. I think this is basically what all the people above said when they agreed in not using credit and mortgages as emergency funds have said. I think maybe we need to have a discussion of what is an emergency and how people who have an emergency fund use it.
I’ve got to side with db and others. You can get savings accounts or CDs online at 5%+ — if your mortgage is only 6%, your opportunity cost is only 1%+ at current rates (depending on how your savings interest is taxed), and if rates go up it may start to make more sense to save more than put it into the mortgage. Plus savings accounts are nice liquid investments, giving you easy access in an emergency situation.
And for those who are concerned that having such a large stash of cash will tempt you to splurge on a trip or other frivolous item, that temptation doesn’t go away if you have enough credit to do it. In fact, I would suggest that forcing yourself to save up a 6-month supply of cash will give you a much better fiscal discipline than telling yourself you’ve got enough credit / equity to pull you through.
Forgive me, but why would paying back your HELOC (or even just a regular LOC – it doesn’t have to be a HELOC) be any more complicated than paying down your mortgage?
I’ve sort of hedged my bets by putting some money toward my mortgage and keeping some more liquid. So I’m not totally on board with the idea of using a HELOC/LOC. Despite being a consultant, I’ve had some dry spells, medical emergencies and even unemployment (I wasn’t consultng at the time), as has my husband. And I tend to be pretty cautious.
I suspect my friend is more confident in her decision, because she bought her home for around $300k with $100k down around 6 years ago and now it’s worth around $700k.
@Andrea:
The issue is that a HELOC, or any line of credit, is debt. Debt in my book is something to avoid. You may well find the payments easy. The issue is having to make the payments.
The key, I think, to building wealth is to make choices that avoid installment payments of any sort. So I’m in that camp of person that thinks even a mortgage is something to get rid of as soon as possible. I’d much rather have a small amount of bona fide cash and no payments, than a big amount of net worth that is tied up on paper and payments.
I don’t really care what your MBA friend is doing — we really don’t know her situation. She could be doing great, or she could look wealthy but be tied up in massive debt.
I think that there isn’t one strategy that suits everybody (and probably, people are not following the strategy that suits them best).
Not everyone feels that debt is an inherently bad thing, not everyone mishandles credit, not everyone is happy with opportunity cost, and the converse is also true, not everyone is comfortable with debt, not everyone can handle credit and not everyone is concerned with opportunity cost.
Having a strategy to use in an emergency that will provide access to cash, is much better than having no strategy. Nobody knows for sure whether their strategy will be optimal in any given emergency so if the strategy you’ve chosen is thought through and doesn’t keep you awake at night then its probably ok.
@plonkee: Well said.
@Andrea: read plonkee’s post. Your friend’s strategy may be a great one for her but not for everyone else. Sure, $30,000 in savings and $30,000 in home equity are both assets valued at $30,000. But taking out a home equity loan is not the same as drawing down a savings account.
I can definitely see how someone in a stressful emergency situation (whatever it may be) would only be more stressed out by having to take on another debt payment at that time and by knowing that even though she’s currently jobless or sick or whatever, she will in the future have to come up with another $30,000 + interest in addition to her other debts. But some people would be fine with that, and the HELOC might be a good solution for those people.
@plonkee: I think that is the key. Just by having a strategy for emergencies whatever it may be is good
If there is a credit crunch, as might happen if the subprime meltdown extends to prime markets, then HELOCs will be much harder to come by, and existing ones might be much restricted.
Not so long ago, banks were tighter with credit and would only lend against a mortgage for ‘practical’ purposes such as home renovations, etc. If those standards return, then a low-interest HELOC may not be there when you need it for emergency funds.
Though you might think a credit crunch unlikely, emergency funds should not depend upon what is likely. An emergency is by definition unlikely, and an emergency fund by definition is a highly liquid, guaranteed source of cash. A loan which depends upon a lender’s willingness to lend a given amount at a given time does not therefore qualify.
A bank can cancel the borrowing privileges of a HELOC at any time, for any reason. They’re more likely to cancel it if the economy sours. Coincidentally that’s the time you’r emost likely to need emergency cash.
And how exactly are you going to make payments on the HELOC?
An emergency fund is for insurance, and that insurance has a cost associated with it. Whether it’s opportunity cost because it’s sitting in a money market or cost is in the form of increased risk form of using available credit or liquidating other investments, it has a cost. Just like there are no shortcuts to riches, there is no free insurance, just different ways to go about it.
There is no absolute mathematical solution because there are too many unknown variables, if there were, we wouldn’t be debating this. This, like many other polarizing financial concepts, will have advocates for both sides expressing religious-like zeal for their position.
Know your costs, know your risks, know your alternatives and then make a decision that best suits you.
My understanding is that HELOC and refinances are typically “Recourse” loans in many states. That is, only initial purchase home loans are “no recourse” in these states. “No recourse” means that the loan is secured by the asset (house) and the lender has “no recourse” to your other financial assets if you are foreclosed on.
With a “recourse” loan (potentially any refinance or a HELOC), if you can’t make the payments and are foreclosed on and should the sale proceeds not pay off all the loans, the lender can choose to still come after you for the remainder owed. This scenario seems like it would become more likely in a time of declining house values, particularly with a larger use of HELOCs.
The bankruptcy laws were quietly changed significantly several years ago also. I don’t understand the differences, but the banks were the ones lobbying for the changes. AFAIK, credit card debt is still discharged under bankruptcy but HELOCs are not. So the banks advertising for people to HELOC their way out of credit card debt amy not be very altruistic.
Another fun wrinkle: If you can’t pay the mortgage, the bank may accept a “short sale”, where the proceeds don’t completely pay off the loan. The bank in this case has decided to accept less than the amount owed, forgiving some of the debt. It turns out that the forgiven amount of the debt is treated as INCOME by the IRS for income tax purposes. The bank will report it because this is the only way the bank gets to write off the loss for its taxes.
In these days of extreme stress in the housing market, these edge cases of foreclosure, short sales, and bankruptcy laws become much more important to understand. If your emergency has the potential to end up that badly, make sure you investigate the details.
How much you need in an emergency fund is determined by how long you think the emergency will last, how long it takes to regenerate that emergency fund, and the likelihood of another emergency happening during the time when you are regenerating that emergency fund. If you think an emergency is going to last 3 months, and it takes you a year to build back up the emergency fund, and you think that during that one year time, you might have another emergency lasting another three months, then you should have an emergency fund that will last you 6 months.
Read my article here:
http://wisdomfrommywife.blogspot.com/2007/03/how-much-should-you-put-in-your.html
Well I wasn’t having luck with trackback, so I’ll post the link here.
I’ve blogged on this in my home trench: How about that emergency fund?
Wherein you’ll get a lot more background to understand exactly why I’m thinking the way I do on this.
Remember, it’s an emergency because it happens unexpectedly, so you can’t control how it happens to you.
db
I have a nice solid number that I like to suggest: At least $4000. It’s based off my own personal experience, and obviously people should adjust it to their own lives. But here’s where I got that number:
My sister’s dog had an intestinal blockage, and it cost them $4000 in emergency vet fees. This is the largest, unexpected, “need the money right away” expense that I’ve seen in my family, so that’s why I go with $4000.
As I mentioned, I still haven’t jumped on board with what my MBA friend suggested. (And I only mentioned her situation, because I thought perhaps someone with no debt other than a $200k mortgage and several hundred thousand in assets might have a different take on things.)
But let’s say you put $30k against your mortgage and arrange for a LOC, not a HELOC. Yeah, the interest rate will be a little bit higher. But it isn’t tied to your home. And now let’s say that the $900 a year you save on your mortgage by chucking in $30k is then set aside in a bank account. (I’m in Canada – no interest write off) So you’ve got extra equity in your house (if you need to draw on a LOC) and you’ve got some money set aside to help with interest. What about that?
I must admit that I’m a conservative. However, I did pay down my mortgage by $30k once I set aside $30k in an emergency fund. So I’m twice as prepared and I figure I can always pull out that extra $30k if I need it.
I think what constitutes an emergency is different for different people. If you’re in your first job living paycheck to paycheck and cannot turn to your family for help, then a million tiny things (like a hole in your work shoes) can count as emergencies, and they can happen almost monthly.
For me, the following things feel like emergencies:
1) Some annual or semi-annual expense comes due. I save monthly for this. (I choose the amount by looking at my current expense.)
2) Something breaks, but I want to keep having it. This still always surprises me, even though I know that things break. I am now saving a certain amount per month for household repairs, car repairs, and my next car.
For the house repairs, I used some rule of thumb (2% of the value of the house per year, I think) and then increased it with inflation. For the car repair, I used the average cost of my first car and now my current car (which is double). For health stuff, I’m starting with $100, which is just a random amount I will modify later.
And I have homeowner and auto insurance, but I try never to use that because they will raise your rates–I mainly use it for bankruptcy prevention. Oh, also I could break. I have health insurance and have finally starting saving a certain amount each month for health costs.
3) I lose my income. I am unlikely ever to be laid off because I work for the state, so I don’t actually worry about that. But I do have long-term disability insurance plus enough sick leave saved up to cover short-term disabilities. It would also be nice to be able to just quit at any time, but for now I satisfy myself with saving for retirement in 7 years and 10.5 months, not that I’m counting, yes I am.
I so far have been saving the maximum IRA contribution (in addition to my employer’s forced pension savings), but I just added some for a new ROTH 403(b).
There are other horrible things that can happen, like you have to travel to visit needy relatives, or you really want to give money to friends or relatives, etc., but these will always surprise me. My current plan is to borrow funds from one of my other categories for that. I can only remember one of those things happening (several times) and that’s wanting to subsidize a relative for a once-in-a-lifetime opportunity, usually a family trip that they can’t afford. I’ve just taken that out of my own travel fund.
My money is actually stored mostly in stocks, but with $500 in a local checking account for very good liquidity and $1000 – $2000 in a high-interest online savings account which usually gets tapped when one of those annual payments comes due. These amounts were selected based on past experience.
It’s true that stocks are risky, and that just when you’re getting laid off (or in my case, my relatives are getting laid off) is when stocks are plummeting. But I figure that if my stocks grow 10% or more per year and then drop 25% right before I need to sell them, I probably still have more money than if they’d been growing at 2-5% a year the whole time and then not plummeting right before I need them.
I have also used credit cards sometimes when several things happened at once and I didn’t want to sell my stocks but I still had my job.
Okay, I think I’ve answered both of your questions. Thanks for asking them; I’ve enjoyed reading these.
I especially like reading what exactly is considered an “emergency,” because no one ever talks about that.
**
Don’t loans against home equity also have big fees?
There are several reasons for the often cited “three to six months of expenses” guidline. 1) If you are out of work due to illness/injury and do not have short-term disability insurance, your long-term disability insurance probably takes effect after 3 to 6 months. 2) Conventional wisdom held that if you lost your job, 3 to 6 months was enough time to find employment. 3) In the event of a disaster (i.e. home is no longer habitable), 3 to 6 months allows time for insurance processing. 4) It is generally a large enough savings to cover unanticipated immediate needs (i.e. sewer back up in the basement).
While #4 may still be true, the other three points are often not. #1: today, most job benefits do include short-term disability, and in fact the long-term benefit is a bigger problem (Social Security integration — that’s a story for another time!) #2: time between jobs will vary widely depending on your career, qualifications, willingness to relocate, etc. (A 2-income household is both a blessing and a curse: one unemployment means you only lose ~50% of income, but it makes relocation more difficult.) #3: we have all heard horror stories about people along the Gulf Coast who are still waiting for insurance payments 18 months after Hurricane Katrina.
In the end, you want to ask yourself what your “emergency fund” is really for, and that will guide you toward the necessary amount.
There are so many reasons this is a bad idea.
The primary one is what if the “emergency” is something that damages the house? An emergency fund is not simply a form of protection from the loss of a job.
I have more than $50k in a money market mutual fund. It is an emergency fund but it also serves as a nice cushion to even out unusual cash flow situations. When we had to have our roof replaced last year I paid the $10k out of that fund and then slowly built it back up.
It’s nice to be able to not have to specifically save for large purchases since you don’t always know when they will occur. You definately don’t want to be in a situation where you need to tap a HELOC to pay for $2000 worth of unexpected car repairs.
Trying to squeeze every last dime of interest out of your investments is foolish in the long run because eventually you will get burned and all your extra savings will get eaten up in some unforseen event you are now unprepared for.
I live and work in Tokyo, so my situation is a little different than most. My original plan was to put away approximately three month’s worth of my salary for an emergency fund before building up an investment fund of approximately 1,000,000 yen (a little less than $10K) and getting cracking.
However, the DISMAL interest rates (0.5%, 0.6% or so…and I’ve looked for better) have caused me to rethink my plan in slightly more aggressive terms. I have about one month’s worth saved up already, so once the credit card is cleared off next month, I plan on doing some relatively low-risk investments (e.g. index funds, possibly currency) to try and get a return of somewhere between 5% and 10%. This will also serve to get my investment feet wet and, once I’ve got a fair amount riding in some safe, easily-accessible investments, I’ll start looking towards more high-risk/high-return strategies.
My thinking behind doing so takes into account the facts that a) it’s very hard to get fired in Japan; b) if the unthinkable happens, companies are generally very understanding and, if that fails, state insurance is very robust; and c) you would get about the same return on stuffing your money into a mattress as you would on putting it into a standard savings account.
I guess the point, then, is that you really have to consider first what exactly your emergency fund is FOR and, once you have, consider just how much risk you’re willing to tolerate. As an individual with a very low debt level, I’m willing to be a little more risky–if I had a family riding on my ability to provide, though, you can bet that the story would be very different.
i break the traditional e-fund into e-fund and contingency or income disruption fund. I’m dead set against HELOC, because you are not guaranteed to getting a HELOC. Let me see, you have no income source and you are applying for a loan = not a good combination. Since you cannot guarantee you are going to get a HELOC, nor can you guarantee how much interest (what’s your credit rating?), this is setting yourself up for a complete disaster. the idea of having cash reserves is so you negate all these factors when you need the money the most.
for me, e-fund is for major repairs or medical/dental issues. contingency fund is for income disruptions. it is variable from person-to-person based off of your job volatility. so the amount will depend. i shoot for mid-level scenario of two major things (i.e. medical/dental and car/house repair) plus income disruption. the e-fund needs to be liquid, whereas the contingency fund can be semi-liquid in laddered cd’s or such, since it is a month-to-month need basis. you have to assess what is likely to occur. if you have an old car or an old water heater in the house, the probability increases of needing cash for a repair. if you have health issues, the probability of needing to seek medical care is higher. if you have older parents or sick parents, you might need cash on hand to buy plane tickets. again, there should be a difference between emergency funds and income disruptions funds.
J.D.,
An emergency fund is actually a risk management vehicle. Your car accident example brings to light the concept of “risk sharing,” which is also an element of risk management.
Where I am leading here is, now that you have a large emergency savings account, you have a greater capacity to bear more risk with insurance (and other areas).
To keep my comment brief, you should consider increasing all of your insurance deductibles to the maximum level. In other words, you have the cash capacity to “self-insure.”
Please think about that if you have not already done so…
Cheers…
“Choose a bank that fits your style” – I don’t think I’ve ever thought of it like that before, but you’re right. For me, it’s tough to not touch money I know is right around the corner…online banking helps me keep my greedy little hands off my money.
Great tip that may seem intuitive to some, but I’d bet for the vast majority of folks, they’ve never thought of it like that.
-Wayne
And the best line on your account statement is “Interest Paid Year to Date $190.65”. That’s pretty good going considering it’s only April.
Plonkee, I agree that the interest line is great, but some of that number is from referrals to other customers. ING counts their referral bonus as interest.
Financial Philosopher — you’re right, I need to increase my deductibles. Or at least price the difference.
Who is this Wayne character? Joking he does great stuff and tickerhound.com
Over the past five months, my EF has grown to just $1,000. I’ve just discovered that my labor union will most likely call for a strike in the next 60 days—a year ago, I wouldn’t have had the financial backup to endure a few days (hopefully just a few days) of not being paid.
The peace of mind that my EF gives me is immeasurable. That peace of mind acts as positive reinforcement to ensure that I’ll continue to add money to my EF (when my debt is paid off), and to continue to economize so I can become even more financially secure.
We, too, our learning to love our emergency fund.. We just have a little over 5K and are also working up to 10K.
We recently used our e-fund when we had some major car repairs, and I felt good about knowing it was there and using it, but even better when we paid it back after just a few months! 😉
I believe the emergency fund is just as important as the retirement fund, if not more important. If you don’t have sufficient money in your emergency fund, then you’ll be more likely to tap your retirement fund and take the penalties involved with that. So, for me, I prioritize the emergency fund over the retirement.
Plus you can decide at the end of the year that you want to shift money from the emergency fund to a Roth IRA. Bingo, tax benefit at end of year, financial cushion for beginning of year.
@J.D. – Another great post. I too am working on my emergency fund and it is steadily gaining. I knew many of these principals before I started reading your blog but I hadn’t been able to actually put them to use. Your everyday real life IMOaccounts have enabled me to do so. I am headed down the path of financial freedom for sure.
@Financial Philosopher – I had not thought of “self-insuring” in those terms before. That is a great idea IF you can assume the risk with your own savings.
Long time listener, first time caller. 🙂 (I’ve always wanted to say that!)
I just want to say that you have no idea how much this article has helped me! I won’t bore you with the details of our financial struggle, but suffice it to say that we are a one-income family living paycheck to paycheck. We have recently tried and failed to set up our emergency fund…actually we got it, then had 2 major home repairs that wiped it out. I have been VERY discouraged, but reading this post today has given me the encouragement I need to get my mind where it needs to be. Thanks a bunch!
I’ve read so many great reviews of ING it makes me wonder I don’t have an account there! I particularly like the sub-account idea where you can basically create targeted savings account as you mentioned above. We call those sinking funds around my house, because we sink money into them each month to pay for annual or semi-annual expenses (car tags, Christmas, insurance premiums, etc.). Having sub-accounts would make the accounting much less messy. I think I’ll finally take the ING plunge.
I had been putting my “emergency fund” money into stocks and bonds. I knew this went against conventional wisdom, but figured I was OK because I also have a HELOC available to me.
Over the past few months, I had a set of occasions that warranted withdrawing emergency funds. And I did that — my taxable stock accounts are down to 0, and I took some money out of the HELOC. Not a problem, I will have the HELOC paid back off within a couple months and then start rebuilding my emergency fund. But now I’m inclined to follow the more conservative route of having that money in a high-interest FDIC-insured savings account.
While in the end everything turned out OK, my stock withdrawals were at a loss — just because the stock market has been terrible lately. And even though I could have avoided the stock withdrawals and used the HELOC for everything (at a reasonable interest rate) I just didn’t feel comfortable with that. I wanted rid of the HELOC debt ASAP.
So my lesson is learned, I will follow the more conservative approach. My plan now is to put all (non-401k/roth) savings into a high-yield savings account — because I may want to tap that money over the next five to ten years.
I don’t know if you do or not, but having a checking account through ING direct is really good for an emergency fund as well. We use the ING checking for our Christmas fund and our car-related expenses. So, we get a debit card with that and use it whenever we need to make car-related purchases. The real benefit comes in when we need to access the emergency fund. We can transfer money to the Checking from Emergency, and it is available immediately.
Obviously, this won’t help the impulse buy disease, but if you can control that, you will have money almost immediately when you do have an emergency.
This system has worked well for my family, I hope that it will work well for you.
As for the self-insurance: we used a High Deductible Health Insurance plan a couple years ago, but burned through that money with our first daughter. Now, I would like to get back to that because we spend so much on our group health insurance now it is ridiculous. $5000 a year! I think that I might be able to find my own coverage for less than that. Having a large savings account sure makes it easier to be prepared for those emergencies.
It’s definitely something you have to get used to. Like you said, it is a great feeling to know that unless there are a string of several emergencies in a row, you’ve got everything covered. It’s one less thing to worry about, and gives you a bit of breathing room.
Thank you so much for your encouraging blog! You don’t know how much it means to someone who is discovering money management for the first time in her life (age 41). It means the world to have a support system like this.
Great article–thanks!
How much should ideally go into an emergency fund? I’ve already paid down my debt and–thanks to an earlier article here–opened a savings account with ING, a bank I definitely recommend to others now.
I’ve read lots of advice that says the emergency fund should be half your annual salary, and you should have that much in a savings account before you even start investing in other places.
Much of it depends on assessing your specific needs of course, but are there any other general rules about the emergency fund? Any more advice would be great.
Emergency Fund Accounts are essential. There is almost always something that comes up and having the money available in an interest bearing account to cover unexpected expenses is far better than having to use a credit card.
@Zack
My e-mail is down, so I can’t reply to you directly. There’s a lot of different advice out there about how much to put into an emergency fund. A lot of it depends on your own disposition. We’ve actually discussed this a couple times before:
* How to start an emergency fund
* Ask the readers: How much in an emergency fund?
Those two articles may give you some useful info.
Many good posts, however I think an emergency fund should be readily accessible and liquid, but not too available. A money market account with check writing privileges meets these requirements. Real estate,CD’s,stocks, bonds and collectibles do not qualify. You are not looking for the highest rate of interest (also the highest risk) you are looking for a place were the money is available when needed. Most financial advisors recommend 3 to 6 months living expenses.
I disagree about priorities. THis is what I would suggest.
People should make the minimum payments on their debt. (Keep reading.)
Cut back on expenses till you have balanced your budget.
Determine how much more you can devote to debt repayment.
Put 1/2 of that toward debt repayment.
Put the other 1/2 in an emergency fund.
When your emergency fund is equal to 1 month of expenses, you can cut monthly savings back. (You still want to eventually have 6 months of savings.)
At that point, start saving for retirement.
Otherwise, a small set back can lead to more debt and perhaps people clearing out their retirement savings while maxing out their cards.
I’ve recently been appreciating my emergency fund lately. We’ve had a medical issue going on in the family that involved hospitalization for a few days and surgery, and it’s great not to have to worry about how to pay the insurance deductibles and copays.
The other great thing about an emergency fund is that our finances have enough breathing room that I’ve just stopped paying attention to prices for a little while. Whatever the hospital cafeteria charges for that food item I want, I pay it. The sick person wants a new book to read or clothes that are comfortable for a hospital bed? Done. It might not fit into many people’s idea of “emergency spending”, but it’s making it easier to get through a tough couple of weeks. Having financial discipline most of the time means you have the cash to spend when you need it.
This is a bit of a tangent from the thrust of the article, but after reading it, I wondered why some people are so resistant to having an emergency fund. It doesn’t seem to matter how much we tout the advantages of having peace of mind even when unexpected expenses or lack of income occur.
I found myself asking whether there are certain group of people who are so accustomed to chaos and fear where their finances are concerned that they don’t really see the need to have them be “safe”. In fact, they seem to be proud of their leaps from crisis to crisis.
(Me, I grew up with middle-class frugality and financial conservatism — I had to learn that it was OK to take calculated risks and make mistakes (aka “learning experiences”.)
OK. End of tangent.
J.D. does it again!!! Another great post. I already have a retirement account with ING through my work, but not a savings account. I like the idea of sub-accounts. What is the best thing to look for when setting up for an emergency fund?
@Frugal Dad – good point about the sinking funds. IMO, an emergency fund is for just that–an unforseeable emergency. Getting hit by an uninsured driver is an emergency; replacing the clutch after 80,000 miles is not. The clutch should be paid for out of a sinking fund while leaving true emergency funds intact.
J.D. I’m in almost the same boat as you, just starting 3 years sooner. I’m just glad that I was able to see the light. Right now I’m on track to have a $2000 emergency fund before the end of the year and I’ve never had that before.
No to just get rid of the rest of that pesky debt….
I love my ING account. Super easy to use and I have several different accounts (emergency, vacation, etc).
I started my emergency fund with ING 4 years ago for the free referral bonus. The referral interest did confuse me at first but you get used to it quickly.
Now the account has grown and I have a goal for 6 months of real world expenses by summer. On track too!
You mention in your post starting a small emergency account first – paying down high interest debt second (which is where I am at currently) – then fully financing your retirement. What exactly do you mean by that? Would that be your strategy if you were 20-something?
Thanks for the advice!
A great post! I agree about jump-starting your emergency fund with a big chunk like your tax refund. That’s what I did. Having that cushion in place really motivated me to get serious about paying off my credit cards.
We’re a huge fan of the emergency fund. We’ve had to use it a couple times, and it has been a blessing.
I discovered your site last November and took to heart the idea of an emergency fund and created one with the help of some snowflaking (which had an additional benefit of cleaning out the closet, which in turn made the wife happier as well, talk about a win/win situation). A string of plumbing mishaps has severely dented the emergency fund and left me feeling rather bummed about it’s depletion in such a short time. I am glad that it was available, I just wish I could have let it grow a bit more. This post has re-ignited the fire to rebuild our emergency fund to a higher level. Thanks for the booster shot. Time to go shake some more snowflakes out of the storage spaces.
I started my emergency fund my last year in college, in anticipation of potentially not finding employment upon graduation. I had about $1800 saved up when I graduated, and had to tap into it for about $500 since then. I am now building it up with $500 every month until it reaches $10k, like you. My problem is I feel like I *can’t* touch that money, for anything. I felt awful taking out that $500 when I needed it (though I was glad it was there). I get so into the mindset of “this is not for touching” that when I need to, it’s hard.
JD, what do you plan on doing with the interest that accumulates in your emergency fund after you save your $10k? Will you count that towards bonus emergency fund money, or will you allocate it elsewhere?
we have 1 month expense emergency fund immediately available in a money market.
we are setting up a good cd ladder. right now we have a 3 month ladder and we are looking to have a monthly ladder. that is to have a cd mature every month, that way if we have an emergency longer than a month we have access to the funds and are gaining more interest than a moner market.
Ah, the halcyon days of having enough money to save…
ING is great for money that you won’t have to touch right away (say, saving for a Wii or some other “want but don’t need”), but I don’t like it for emergency saving because it takes about 2-3 business days from the time you set-up the transfer to the time that you see the money in your linked account.
If you had a Credit card, you’d because you could use that to make whatever payment, then set up your transfer and pay off the card right away, but if for whatever reason you just needed CASH right then and there, you’d be in trouble.
So I guess the best case scenario (other than not needing to have the money for an emergency) would be:
1. A easy to access $500-1000 “emergency emergency” fund
2. A interest bearing “back-up” emergency fund.
We have an emergency fund in the form of a credit card as well. It is backed up with an emergency fund in a high-yield savings account and a money market checking account. If we find ourselves in need of the money immediately (since I rarely carry the emergency fund debit cards around with me), we use the credit card and then make the necessary transfers to pay off the credit card balance.
Great case in point- I just had to tap MY emergency fund for my 3k+ tax bill. I’m sure glad I have one- I wasn’t expecting to owe so much!
For me, my emergency fund is a catch all for rainy day spending, emergenies, and yearly expense items. I budget out the fund with a google doc to help keep track of what I have it in.
I’ve been pondering this a lot lately. Last week I paid of my HELOC, so my only debt is my mortgage. I have about $3500 in a liquid savings account; and $1000 in a brokerage account that is slightly less accessible.
My dilemma is whether to put the amount I’ve been paying monthly on my HELOC toward more liquid “emergency” funds, put it toward eliminating my mortgage (@5.25%), or put it toward my retirement investments. I already put 10.5% of my income into a 401(k).
The answer is different for everyone, isn’t it. Personally, I’d love to be out from under my mortgage. At the same time, I can’t easily pull cash out of my home other than taking an advance on my HELOC. What to do, what to do…
This was just the article I was hoping would come back up. The idea of an emergency fund is a crucial part of any financial plan, which is why I started mine now instead of waiting to become debt free. I feel that an emergency can be a real set back to my debt elimination program if I don’t prepare to be able to weather it should it occur before the debt is gone.
I use a multi-tiered emergency fund made up of emergency cash-on-hand at home as tier I. I use my credit union accounts for tier II, which is made up of 6 savings certificates (basically, CDs) each with a 6 month maturity laddered (i.e. purchased) one month apart, a checking account and savings account. The savings certificates ensure that I can get a high interest on money that I most likely will not use except in the most dire of emergencies that cannot be handled by my cash-on-hand and the savings and checking account. Soon, I will implement tier III, which will be 12 Series I savings bonds laddered (i.e. purchased) one month apart. These will only come into play if the first two tiers aren’t enough, and they will grow to full maturity tax-deferred and interest rate indexed until used. I think I have a good mix of very liquid and not so very liquid stores for the money.
Great post JD – from small seeds grow great things! It is only since starting to read pf blogs and really get ourselves organised that we have managed to get our Emergency Fund to $8000 – since Nov 07. I have been overwhelmingly, delightedly amazed we could do so well in such a short time….and acutely ashamed that we were spending those funds willy nilly beforehand. But, is all good now..although takes a little while to ‘drop’ some of the worry…for example, things were a bit rocky at work and I started to fret until I thought ‘Doh, you have 3/4 months worth of emergency money – that is almost probably enough time to find a new job’…it is has been a very comforting revelation.
Thankyou again JD for your candid and refreshing posts – I wonder how many lightbulbs your words turn on? They have certainly provided me with a lot of motivation and changed the way my family lives today..and more importantly, tomorrow. Thankyou.
Lorraine
Very good post. but I’m just curious – why ING and not HSBC. HSBC has a 3.5% APY rate I believe, and ING is at 3.0%.
The only reason I ask is because I have an high-yield online savings account with HSBC, but lately since I’ve heard so much about ING and their subaccounts, I’m really tempted to switch. However, I’ve also been warned to limit the numbers of accounts I open for security reasons (having more accounts = more opportunities to have my identity stolen).
Why not HSBC? It seems like they have a pretty high rate of fraud.
http://consumerist.com/search/HSBC/
I adore my emergency fund! It’s as if I was being followed around by a group of people holding a basket lined with cotton, for me to fall back into should I trip. I love that security.
I dumped everything into mine for a few months, so since starting a few months ago i have $2000. And the best thing is, I’ve never saved anything before, and I’ve already made $12 in interest!! If I leave the savings at that quantity (and I won’t, I plan to save for other short-term goals on top of it) I’ll make $100 a year in interest! JOY!
I can’t stress the importance of the emergency fund. Specially for people starting to pay off their debt, and seeking financial independence.
The peace of mind you get knowing that money won’t be an issue in case of an emergency is priceless. About three weeks ago, my car broke down. For the first time I didn’t feel a sense of panic during an emergency. In fact, it didn’t feel like one. Instead it felt like a slight nuisance. I love the emergency fund!!
Great post. And great blog in general. I only found you a couple weeks ago, but I love your style.
My husband and I are both savers, which cuts down a lot on the money arguments.
We found out a few years ago just how important an emergency fund can be. Four months after our daughter was born, while I was still on maternity leave and not earning any money, my husband was laid off for the first time in his career.
We didn’t really see it coming, and it took a nerve-wracking 4.5 months for him to get a new job. During that time, our washing machine broke and had to be replaced and my best friend died at age 37 and we flew from PDX to Chicago for her memorial service.
We also had to pay $1200 a month to keep our health insurance via COBRA.
And although we cut it close, we managed to do all of that without having to dip into longterm savings after cutting our budget to its barest minimum.
(And it worked out well in hindsight. Not only did my husband get to spend WAY more time than he would have with our daughter during her infancy, but he ended up with a better job and a significantly higher salary. I just wish we’d been able to spend those 4.5 months enjoying them without the worry of how long it would take to find a job.)
Needless to say, the first thing we did once he was employed again was build that fund back up, and we continue to add to it since our expenses are increasing as our daughter, now 3.5, starts preschool.
This is great advice. I only recently started saving (age 30) and actively paying down my credit card debt. I just opened an ING account with a bonus check and can’t wait to get my CC debt paid down.
I have us on a 12 month spending plan to pay it all off. It is amazing when you star looking at budgeting where all your money goes. I know we have been wasting too much for too long.
Thanks for the great advice and keep it coming.
“I need to increase my deductibles”
From my experience, the nice thing about increasing deductibles is when you slide off the road into a mailbox 3 months after doubling the deductible, the insurance company doesn’t spend much time looking at you as a possible fraudster 😉
Ha ha, my credit union pays 1.10% on my share account. 😛 Which is still not wonderful, but as I understand it, most banks pay less than one percent interest on regular savings accounts, and obviously at least some credit unions do as well, so I wound up with a good’un. At this point I’m more worried about getting the emergency fund together than about what interest rate it’s paying, as I don’t use my savings account for an investment account. I think I should worry more about interest rates when it comes time to invest. But your mileage may vary.
Oh, and… I don’t know that I really had it drilled into my head about savings when I was growing up; I think my parents fell somewhere in between on the continuum. The last savings account I had as a kid–we had to change banks sometimes because we were a military family–I opened it with my stepmom in 1989. I didn’t close it until eleven years later. 1989 was my first year of high school; after I left home I sent money to that account periodically and at one point I had amassed over two thousand dollars. Then my then-husband decided I was an idiot to squirrel money away when we had credit card debt and demanded that I take the money out and pay bills with it. Thank goodness my stepmom had sense to not completely drain the account. And I learned a harsh lesson: even married people need their “own” money that has nothing to do with the other spouse. Because if nothing else you need some kind of backup plan in case the two of you get completely turned around about your financial approach and wind up in trouble.
Oh, and sorry for the multiple comments. Dunno if I have said it here before or not, but ING is picky about what customers they take on and keep. I got dropped with a letter from them stating that they had run a credit check on me and would not do further business with me because my credit was too bad. I knew my credit was bad, but that was the first time a bank ever told me to get lost over a savings account, which has nothing to do with credit whatsoever. I don’t think I’ll go back to them even when I improve mine.
Andrea the one who suggested using equity line of credit lives in Canada. Nuff’ said.
I am 29 years old and have 2 jobs. I have a 6 month plan to pay off all my debt and am taking every advice I can on how to save money. Your situation is just like mine, as my parents too have a really hard time saving money. I still have a lot of questions, such as where to put saved money eg. mutual funds, CD’s??? I am working on saving 17,000 in 10 months and pray to God I can keep these 2 jobs as long as I live as they are both great jobs and they take up most of my time, leaving me little time to spend.
Actually, I need a little financial advice. My mother will be retiring as a nurse by the end of the year. Is there a chance to purchase a home with a Downpayment of 15,000. I have tld my parents that I will put the downpayment along with the closing costs for a condo, as long as they pay the rest of the mortgage.
Chris,
I see that nobody knows an answer to your questions. It is very difficult what you are trying to do, and I wish I could give you an answer, but I really do not know anything about this. I am extremeley new in savings, and I just opened 2 accounts with ING, which pays 3%. If someone needs a referral code to win $25 when opening an account, with a minimum deposit of $250, send me an email at [email protected]. And I will gain $10. Everyone happy! 🙂 Chris, once again, good luck and do not give up!
Andrea, I disagree. You’re NOT ahead. Why? Because you are not “pulling money out” – you are BORROWING AGAINST YOUR HOUSE, AND IT HAS TO BE PAID OFF. By doing what you’ve described, you’ve given yourself a second mortgage and put significant additional risk on the roof that’s over your head. If you’re unemployed for a long time (your definition of “emergency”) and can’t make a couple of payments, you’ll lose your house very quickly. I’ll never understand why so many people put their home at risk in this way. Same thing with credit cards – you’ve got to pay them back sooner or later. Why take on that risk? I don’t own a home, but if I did I’d never ever set up a HELOC to serve as an emergency fund, nor would I rely on credit cards.
I’m currently building up my checking account with the goal of always having $1K there. That will be the first line of defense – to cover things like winter heating and car repair, so that I don’t have to use the EF for smaller things. My emergency fund is currently 3 months of living expenses, and I’m working on getting it to at least 6 months. I keep my EF in a bank savings account – not the best interest, but the large balance means I can do all my everyday banking without worrying about monthly service charges, plus the convenience of a large ATM network if I ever needed to tap the EF.
Well, things have changed since this post! I have friends with excellent credit whose HELOC has been pulled completely. Several folks I know in very “secure” jobs have been laid off.
But, for me, I finally hit $1,000 in my emergency fund (Dave Ramsey’s first benchmark), and I am excited! Its not enough, but its a milestone!
We are a one income household and my emergency fund target is 6 mos. of take home pay, which I roughly consider my living expenses (i.e., after deductions for taxes, ins, 401k and diversion of a small amt to a general svgs a/c). I have almost 5 mos. saved and it’s a big relief to have rebuilt the fund after using a big chunk of it for home improvements last year (no, they weren’t emergencies). I’d prefer my emergency fund to be sitting there strictly for emergencies, but quite frankly I don’t do a budget and haven’t tried to determine/calculate how much to put aside for home and auto repairs/maintenance. I’m new to this site, so I’d be interested in seeing if there’s anything here about how people do that and where they stash that money (separate bank accounts, etc.)
I also disagree about using a HELOC for emergencies – after all, my idea of an emergency fund is to not have to lose my shelter, and the potential inability to repay the heloc is akin to inability to pay the mortgage.
We are shooting for 4 months necessary expenses. This does not include things like cable TV or ballet lessons for our daughter. It’s for food, utilities, mortgage, and internet to find a new job. 4 months expenses for us would also equate to the amount we’d spend on a reliable used car in the event our 95 Jeep decides to die on us.
Above all, emergency funds need to be LIQUID. Stocks can go up and down. Murphy’s Law dictates they will be down when you need the funds. Put it in a high yield savings account or CDs.
I can tell you from personal experience, have 6 months expenses in an emergency fund. Two years ago we bought a beautiful house that we could easily afford on my husband’s salary and profits from his business of 12 years. We put 20% down and have a 30-year fixed mortgage so we had plenty of equity – and I saved 8 months’ expenses into a set of laddered CDs. Well, last summer one of his big clients broke a contract, stiffed him for a lot of money, and his company couldn’t recover because of the down economy. He stopped drawing salary in November and the business went down in December. I was working by then, but not making much. We had huge mortgage payments to make on a home that had lost 25% of its value, tuition commitments for our kids’ school, a lawyer to pay to protect us from the business bankruptcy, and everyday living expenses to meet too. Running up balances on our credit cards or a home equity line would have been the most foolish thing we could have done.
Sadly we now have to declare personal bankruptcy because of the business debts. But with our emergency fund we were able to keep our personal credit clean and our heads high. The good news is that my husband has a job again (after 6 months) and my business has picked up…and although we will have ultimately lost a lot of money because of all of this, we have a renewed commitment to re-building those reserves, divorcing ourselves from the “rat race” and concentrating on achieving financial independence as quickly as possible. I hope others will read this story and consider it a cautionary tale and a wake-up call…good luck to all!
I was working toward the 3 months of emergency funds and was doing ok. But Murphy decided to vist me. An abcessed molar which needed a root canal. Ouch two ways. Foolishly I had not signed up for dental unsurance at work. So a big bite was taken from my emergency fund. I learned the valve of having this fund. I also will get dental insurance at the next open enrollment. Thanks to JD and all of you for your wise thoughts and information!
I have to totally disagree with having a HELOC for an emergency fund. As has been mentioned several times, in the event of a real emergency (hurricane, tornado, flood, etc), banks will clamp down on their HELOC’s or cancel it all together. In addition, with tightening lending standards these days, banks are ready to just willy-nilly give access to equity that may be in your home. I think it might be best to have one open and unused just in case something truly catastrophic happens in your personal life (health deteriorates, etc). We personally shoot for 6 months of take home pay to be in savings and laddered CD’s at our bank. We also have a seperate savings account for budgeted trips and events during the year, so if push came to shove we could cancel those planned trips and use that money as well (which is not included in the 6 month calculation above). So I would vote we have almost 8 months in liquid assets. We are a military family, and although everyone thinks that is like the most stable income on the planet right now, you never know where/when the next major move could come, and each time I have to find a new job at his new duty station. So there may be extended time periods where we are living off one income, which we can do and still save and invest, but not nearly as much as we want. Also, since we rent each time we move, we generally need a security deposit, plus an additional 1 to 3 months of prepaid rent to reserve a home in a new area. This adds up quick! So in years we move (which is every even year right now), we divert savings and investing to a “moving” account that pays for these expenditures, including a trip to the area to go house shopping. So our “odd” years are ones in which we save the majority of our cash for investing and the even years are the moves (which usually follow with at least 3 to 4 months of me being unemployed). So our emergency fund continues to grow, but our savings and investing amount tends to change depending on whether or not we have a move that year.
Just for informational purposes: We have moved 5 times in 8 years of marriage. We went from FL to Norfolk to Rhode Island to Pensacola, to Mississippi, and 2 different stations in Washington state. LOL. We are now facing a move to San Diego for 2 years, then Monterrey Bay (yeah the closest move we have had yet! Just 4 to 5 hours north!), and then to Washington DC, then probably to Hawaii, and then to Belgium. From there, who knows. LOL. Got to love the military. LOL.
Based on my my life circumstances (young,single,condo-renter) my primary concern that would see me tapping an emergency fund is loss of employment.
Do others include things like unemployment insurance payouts or accrued vacation (that would be paid out upon loss of job) in their emergency fund calculations?
EXAMPLE:
Expenses (monthly) – $2,500
After-tax unemployment insurance (monthly) – $1500
Accrued vacation – $4,000
In this example, how much would you save in cash if you wanted a 6-month emergency fund?
I have a friend who got laid off in May 2009. Today, Jan 2010, my friend is still aggressively looking for another job. Every credit card has been exhausted just to cover her mortgage all these months. Her house would be paid off 6 years from now, she has exhausted her resources to keep from losing it. So, how much is enough during a recession? You do the math, but I can tell you that books that say that you need “a couple thousand dollars” should be thrown into the fireplace.
Wow, interesting to see the changing mentalities over the course of 3 years. I love the comments that state that credit is all you need in the event of the emergency. (Sarcasm.)
I’d like to bring this thread back to life to ask if people have changed their approach given the state of the economy. We are a two income family, no children and we own our home. We are a few years into a 30 year mortgage. We have saved a year’s worth of basic living expenses in an online savings account, and I sometiimes worry that that isn’t enough!
What is everyone else doing these days?
I like the idea of layers 🙂 People tease me about having an “emergency $20” in my wallet (I don’t carry much cash), but I also have some emergency cash around my home in addition to savings.
I really think people need to look at what emergencies they might have and plan accordingly. For instance, as I look towards home ownership I’m building a larger emergency fund to deal with things like furnaces or appliances dying (things I don’t need to worry about as an apartment dweller). I also don’t live in an area prone to natural disasters like floods or tornadoes, but if I did, I’d plan for that too.
One advisor told me to keep part of my emergency fund in my RRSP because if I lose my job and it was my source of income, then the tax implications are moot. For me, replacing a furnace or appliance isn’t an “emergency” — it would be part of a home maintenance fund I’m building.
I also don’t carry much cash. There have been a couple of times that an emergency $20 would have come in handy and I had to borrow. Once was for a taxi when my car wouldn’t start, and once was when the restaurant’s credit card system was down.
Incorrect statement about Roth Ira withdrawals. Withdrawals from regular participant contributions are used up first according to ordering rules.Tax and penalty free no waiting period. More complicated subject for taxable and non taxable conversions and earnings before 59 1/2. See IRS publication 590B
I always cringe a little bit when people recommend using a Roth IRA as an emergency fund for exactly this reason. Personally, I follow a layering strategy as well that I believe in.
1. $100 cash on hand
2. One months living expenses in checking
3. Five months living expenses in an online savings account
I agree with this. Just this week, having the checking account buffer became important when the bank screwed up our paycheck direct deposits on March 31st and I and other co-workers had mortgage payments scheduled to be taken out on April 1st. Because of their screw up, our deposits will not be in our accounts until Monday the 4th. So, that also means a full weekend without money that we were counting on.
Storing your emergency fund in layers is probably the best idea.
Prepaid debit cards and cash in the mattress leave you very susceptible to theft or disaster. Certainly have some cash on hand if you need it in a pinch.
As long as your fund is fairly liquid in a bank or investment, or can be quickly, I think that is good enough. My credit card has a 20k limit, and whatever I need to pay for I can charge to the card. Then put the funds into an account and pay off credit card. Note that I am not advocating using the credit card itself as the emergency fund, but rather the vehicle that closes the gap you would need to liquidize your emergency fund.
I had no idea about the basis/earnings calculation for Roth withdrawals. I’m glad I read this article before then; I might have made this mistake in the future.
That’s pretty lame the government gets to decide what’s basis and what’s earnings. Oh well – we do have roads and police I guess.
I don’t think that your information is correct regarding the taxes on withdrawal of contributions from a Roth. The Roth is a nice place for some emergency money (if you can’t max out the Roth for retirement), because you can take out contributions tax free.
From IRS.gov (https://www.irs.gov/publications/p590b/ch02.html)
The ordering rules for unqualified distributions are the following:
1) Regular contributions.
2) Conversion and rollover contributions, on a first-in, first-out basis (generally, total conversions and rollovers from the earliest year first).
3) Earnings on contributions.
I also agree with Adam. However, I’m not a tax professional. I wonder if someone who has actually done this could confirm.
I think the article needs more clarification on this point. If what Cowie is asserting is actually true, this is a major big deal in the world of personal finance. If it’s false, he needs to edit his article. It would be irresponsible to leave this up.
I have withdrawn my original contributions from a Roth IRA before for the purchase of my first car. When tax time came around, I inputted the withdrawal information and had $0 in tax liability. Your withdrawal will be a non-qualified distribution and you should receive a 1099-R with a “Code J” most likely, but withdrawal of YOUR CONTRIBUTIONS are NOT taxable.
TurboTax and any other tax software, accountants, etc. ask how much you have contributed to your Roth accounts so that it can reconcile that your withdrawal is not a taxable event.
Could be true — it is best to talk with someone who really knows, though. But the post was more geared to the thought that there may be better places to save your emergency fund than the Roth IRA…
If the author is correct there are articles on this site as well as just about every personal finance site that need updating! Just to give example to the majority belief vs what he is saying.
5.5K in, wait 5 years, new balance 6.5K, 5.5K out.
Majority: No penalty or tax (1K balance remaining)
Author: 1K gets added to your income this year and you pay a $100 penalty.(1K balance remaining but part is “contribution” still).
Can someone get this fact checked by an tax accountant!
William got it wrong for Roth IRAs. Take note that the codified law states that you must take it in order with your contributions first, roll-overs next in a FIFO and earnings third.
Here is the relevant U.S. Tax Code Title 26 Section 408A specifically under d.4.B
(B) Ordering rules For purposes of applying this section and section 72 to any distribution from a Roth IRA, such distribution shall be treated as made–
(i) from contributions to the extent that the amount of such distribution, when added to all previous distributions from the Roth IRA, does not exceed the aggregate contributions to the Roth IRA; and
(ii) from such contributions in the following order:
(I) Contributions other than qualified rollover contributions to which paragraph (3) applies.
(II) Qualified rollover contributions to which paragraph (3) applies on a first-in, first-out basis.
Any distribution allocated to a qualified rollover contribution under clause (ii)(II) shall be allocated first to the portion of such contribution required to be included in gross income.
We’ve built up a pretty decent chunk of change that we keep in an online savings account since it pays a lot more than a regular bank. Although it’s still only 1%, I do like having the cushion there. We need to keep it a little more liquid since we also use it for down payments on rental property.
I didn’t know about the basis and earnings when pulling contributions out of a Roth. That’s good information to know… better now than when you need it!! 🙂
— Jim
I would also suggest putting money in Treasury I-Bonds. They have lately been getting much better interest than savings accounts. There are two disadvantages. The first is a minimum hold time of one year. The second is that between years 1 and 5 you lose the last 3 months of interest.
They aren’t as liquid as savings accounts but I think the slightly higher interest rates make up for it.
Good thinking. Laddering a roster of those instruments might alleviate the liquidity somewhat…
Ya. I do this. It takes a while. You have to ladder slowly because of the withdrawal rules. The advantage I see with this approach is that it allows you to build a conservative portfolio if you want. I follow Graham’s 50:50 rule on investments (outside of ROTH, 403B, and 529 options). So I currently have 12K in conservatively funded stocks and 12k in i-bonds. This grows by a couple of thousand in each account each year. Very slow. Boring. But I do think that one emergency people rarely think about is the upside advantages of having cash to hand should a bear market roll around. The twelve month e-fund seems like a good rule of thumb here, with notionally the idea that should a good buying opportunity come along, then 6 months could be used for a quick Vanguard purchase or the equivalent of full market funds. I know it is a conservative option, and others would say I’m sitting on gains/speculating, but 24K invested in this way does make some money. It provides me peace of mind by not being exciting. It grows. Not a lot. And I’m taking advantage of the other investment opportunities that are out there for someone in my income range. The i-bond rate right now is 1.65% for most six month increments.
I have been looking into online high yield savings accounts and ran across IRA CDs which have a 2% interest rate when you choose a 60 month term. For me that would be the way to go if this doesn’t effect how much you can put in a ROTH IRA. However, I cannot find much real information about IRA CDs and if they are any different than a regular CD other than offering better rates. Does anyone know?
I think you’re mixing two different tax treatments with regard to how Roth distributions are taxed. The rules you listed aren’t the Roth distribution rules, they are the rules for withdrawing from a TRADITIONAL IRA with non-deductible basis. With a Roth IRA, distributions ALWAYS come from contributions first, then conversions, then earnings so there would not be tax or penalty in your scenario. Everything else I agree with though.
I am not a tax expert — I interviewed a professional with more than 30 years’ experience, and those were his opinions.
However… it still leaves the main point: there are better places to save your emergency fund than a Roth IRA.
The layered approach (cash, prepaid card, savings & CD) offer more safety and more liquidity, and don’t expose you to the risk of the tax guillotine preventing replenishment or having to sell at a loss. (If you think about it, the likelihood of needing money often coincides with a recession… when the value of the Roth IRA might be at a low point.)
And, of course, you will always still have the Roth IRA as the final layer, for when the emergency is that big and that bad.
The point was just to mention that there might be a better place to save for your emergency fund than to blindly pile it all into your Roth IRA…
Except the reason for putting your EF in your Roth is if you DON’T have enough funds to save for both. If you only have $5500 to save per year, should you save part for retirement (in your Roth) and part for your EF (in a savings account etc like you recommend) or should you max out your Roth knowing that if there is an emergency you can pull from your Roth without a penalty as long as you have had the account for five years? The obvious answer, as Ms. Orman knows is to max out the Roth. Basically your entire has a flawed biased and you should read your own sources before publishing.
Correction to my last sentence, I had a typing error: “Basically your entire post has a flawed basis and you should read your own sources before publishing.”
Great article, and the layer concept is what I landed on a few years ago. Some emergency cash “under my mattress,” some more cash in a savings account that I can transfer electronically to my checking instantly, and then the remaining big chunk of my 6-month emergency savings in an investment account in index funds. I dumped my CD ladder a few years ago when it became clear that interest income would be negligible, and because I haven’t had to dip into that portion of my emergency fund in 10 years, it’s really there just in case I am out of work for an extended period of time.
I wouldn’t recommend Roth IRA to be treated as an emergency fund. What if the market crashed and the money you put in is down 20%? Does it make sense to pull money out?
There are other times when it might make sense to pull money out of a Roth IRA – The best place to keep your emergency funds is in a savings account – the old fashioned way. Investing in no penalty CDs and laddering them would be the best route to maximize the returns.
What kind of emergency creates a need for the emergency fund within minutes – or even hours? I’ve never met a doctor or home or car repair person that needs to be paid within minutes or hours. A savings account that can transfer within a couple of days along with a credit card for smaller immediate expenses seems like it would always be sufficient. And what if the emergency is your house burning down? There goes your mattress money.
What about lines of credit? If what we’re talking about really is an emergency fund, then use a HELOC for instant liquidity, and quickly pay it off from less liquid sources. The interest you’ll pay will be trivial because you’ll rarely draw and you’ll pay it off quickly, but the returns from having most of your funds in other investments will be substantial.
I would assume the problem with a HELOC may be that if you loose a job or the value of your property goes down, you won’t have access to funds from a HELOC.
Orman is both right and wrong.
If you have no other source of funds and have a true emergency, then by all means invade your Roth. You can figure out how to deal with comeback issues after the emergency.
But planning your Roth as your emergency fund is poor planning. Your emergency fund should be liquid money within easy reach. Actually, it should be disposable income that you didn’t dispose of stupidly.
I hate the term “emergency fund” anyway. I prefer to use the word ‘reserves’ because then I look at everything at my disposal should the need arise.
Also, the real problem is that some people use the term emergency a little too loosely. Buying ANYTHING unneeded does not qualify, and beyond food, shelter and basic transportation (and medical as needed), not very much else qualifies. Just my opinion.
I was wondering about that too. When I first read the article, I thought: “is a new furnace really an emergency, or something homeowners should budget for in a reserve fund?”
I mean, you own a car, you hold money aside for car repairs. You own a house, you hold money aside for home repairs. If you can’t afford to do either of those things, how can you afford to pay back your emergency fund when you use if for just about every “emergency”?
As I said in my comment below, putting emergency cash in a retirement account can make sense if you only touch it when you need income to live on, not to replace a furnace or something. I don’t use my RRSP for this purpose because once you take the money out, you lose the contribution room forever. With a TFSA, it’s after-tax dollars so there are no tax implications and you can replace the cash next year.
I’m not American so I don’t know enough about Roth IRA, but if it’s like a TFSA then it’s just a type of registered account and you can hold a variety of different investments or savings within them. The real question is “do I use up my contribution room for my emergency account or not?”
That’s pretty much how I view my efund. I don’t have separate accounts for repairs because it’s hard to predict and I don’t like having multiple accounts. My motivation for saving an efund is predominantly job loss or inability to work (or desire not to work for a certain period of time).
As for large expenses, I can usually put them on a cc and float it for 30-50 days. I pay as much as I can from checking and paychecks in that period, and if it’s not enough by the time the bill is due, I feed the balance from my “reserves/efund”.
I also have the same savings for future goals (house, car, school, etc). I figure in an income loss situation I will raid anything at my disposal, from least to greatest in terms of cost to future savings, so having different buckets for me, is moot.
I’ve also done the opposite and when a money-saving opportunity presents itself and I feel secure in my income sources, I’ll raid my efund for that as well. Really for me it’s what feels most important in the moment.
Separate accounts for every budget line item doesn’t make sense. Once you realize that (looks like you did) then you can take the next step and look at your household account just like corporations do: Multi-divisional nested inside one account number.
I’ve seen people budget with envelopes, contribute to Christmas clubs etc. None of it made any sense to me – you had the same amount of money at the end regardless…. unless you were really stupid and put yourself into retail therapy, that is.
For operational expenses, don’t go Hollywood. The simpler, the better. Just understand what is going to be spent out of it one way or the other and make sure there is enough in there to cover everything you think you’re going to have to pay … and then add at least 10% for the things you didn’t anticipate.
And don’t forget to enjoy your money either. Saving it without treating yourself once in a while … whether it’s an ice cream cone, a new car or a short vacation, enjoy life. Money is just a tool to that end.
Read Francisco’s speech from ‘Atlas Shrugged’ if you really want to know what money is.
(This comment came from Michelle, a reader of our daily newsletter.)
Longtime reader here. Love the wealth of personal finance information that GRS provides. However, I was shocked to read William Cowie’s article on Roth IRAs this morning. He makes a critical error in his explanation of withdrawing contributions from a Roth IRA. Several readers point this out in comments, but I still think the article needs to be corrected.
Cowie- you should have done a little more research on this before presenting it as a central tenet of your argument.
Emergency fund number 1: Cash in my wallet. 200 USD or foreign equivalent in emergency transportation money to get me home or to my hotel
Emergency fund number 2: Credit cards (multiple, non-prepaid) and frequent flyer miles to cover home improvement and travel emergencies.
Emergency fund number 3: My taxable investment account.
Emergency fund number 4: Retirement investment accounts (401k & IRA). Do not use unless you are dying of cancer.
Do you have money somewhere to pay off #2?
Just want to echo what some others have said regarding how you described Roth Distributions. Here’s some excerpts from the IRS doc you linked that explain pretty clearly that contributions are withdrawn first, they don’t average out the account for Roth IRAs as you specified:
“If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA.
…
Order the distributions as follows.
1. Regular contributions.
2. Conversion and rollover contributions, on a first-in,
first-out basis (generally, total conversions and rollovers
from the earliest year first). See Aggregation
(grouping and adding) rules, later. Take these conversion
and rollover contributions into account as follows:
a. Taxable portion (the amount required to be included
in gross income because of the conversion or
rollover) first, and then the
b. Nontaxable portion.
3. Earnings on contributions.”
I’m in agreement that you shouldn’t use a Roth IRA as an emergency fund, but one of you primary reasons is blatantly incorrect which is especially funny because you called other blogs as “wrong” without actually doing a fact-check.
If you make 12 – 18 purchases a month for anything, put your emergency funds in a high-yield checking account. My bank pays 3% interest on amount up to $10,000. I use the monthly interest on my accounts… I own two… to buy high risk ETFs on the Robin Hood app, fee free. The tax consequence on even $20,000 is nominal, and the small amount that those ETFs make tends to offset what Uncle Sugar hits me with.
I believe you are incorrect about Roth IRA withdrawals and this percentage breakdown.
Bogleheads forum has some simple language surrounding this that isn’t as complex as the IRS language.
Regarding Roth IRA’s: Regular Contributions can be withdrawn at any time with no tax and no penalty.
I agree that the 80/20% thing is incorrect. I have personally taken out money from my Roth up to the level of contributions and not been penalized. I did it in 2013 and 2014 and unfortunately forgot to fill out the correct form showing how much I had in contributions. So they sent me a letter telling me I owed some huge chunk of money and I filled out the correct paperwork and sent it in and they were satisfied. Both years. I had taken out almost every dollar in principal (long story…had to pay off a car to get my refinancing on my house approved), and they did not consider it 80/20 but were OK with the full amount up to the level of contributions.
I disagree — the time guillotine and psychology work in FAVOR of my using a Roth as a substantial portion of my emergency fund. If I were to have put the money I put into my Roth into a non-Roth savings account over the last year — there would be no Roth, and as of April 15, no opportunity to ever put it in. Hopefully, I won’t touch it — if I do, well, doesn’t really affect what would have been in the Roth had it not existed in the first place. Second, I personally have a far higher threshold for what constitutes an emergency to withdraw from the Roth than from a non-Roth savings account — I know myself, and this is a major reason that I could never get a substantial emergency fund going before taking Orman’s advice. My Roth is in savings account and IRA’s. Once I reach a certain threshold, everything above that will go into equities. And as I change my behaviors, I hope to build up non-Roth emergency funds — but for now, it works for me.
I like the staggered or ladder approach to having your E Fund in multiple places. Each place serves a specific purpose around the amount saved and the need for liquidity.
Of course, I am not following this great advice – ours is a combination of our checking and savings account. (None under the mattress)
I am holding off on CD until I have enough set aside to begin putting into 1, 2, and 3 year ladders while rates are so darn low. Also thinking about putting a small portion in an S & P 500 Index fund that would not be touched for at least 5 years or a worst case scenario.
Saving in an IRA seems horrible to me – but I live in and work in an industry where there’s high turnover and firings even if you’re liked and do good work (startups in Silicon Valley). It’s crucial to me to always have that 6 months in online savings, transferred to checking within 3 days. Even a CD can’t really work for my situation.
I also have 4-5 various other savings accounts for medicalexpenses, car expenses, savings fund for a laptop emergency, and pet illness emergency, all separated.
I don’t plan to touch my Roth IRA at all.
I’ve certainly heard the arguments that you can use your Roth Ira for emergencies, but it’s something I’ve never considered. I treat retirement accounts as hands off period and when it comes to emergencies, I’m not really concerned about gains. I’m concerned with dealing with the emergency and/or survival. I will more than likely continue to keep saving for retirement and earnings from investments very seperate in the future to avoid over complicating things.
NEARX ticker is a short muni national that pays 1.5%/year with a $5000 minimum
I enjoy William’s articles and I realize I am unintentionally going with the layered strategy. However, if there is a major known inaccuracy in the article, shouldn’t it be corrected? I am concerned for all those who will read the article and never read the comments.
Me and my friend were just discussing this. I think it comes down to personal risk tolerance, your family needs, and your needs for cash. For instance I have many children and a rental property so I need access to funds pretty quickly just in case. But a single person who lives in an efficiency apartment and rides a bike to work may be able to hold less – or put a greater proportion of emergency funds in a brokerage account. Like your article – thanks.
“Emergency” is a strange word. I hear “emergency” and I think I (or someone I care about) is stranded or hurt without help — something has happened to one of my people. If something breaks in my house or if my car breaks down, that falls into a different category, and I build savings for repairs and replacement of those things. My retirement accounts — Roth and otherwise — are hands-off. Always. Dipping into my Roth would be a crazy slippery slope for me.
Generally, I don’t use cash for daily or walk-around spending, but I do have an emergency $100 in my wallet. I also have a credit card hidden away in my purse just in case someone steals my wallet. I just need stopgaps to get myself home to take care of whatever might have happened.
I have worked freelance for over 10 years, so I’m used to times when things are leaner than others. And I’m solo these days so it makes things simpler — I am sure this is a much tougher issue for those with families. I use credit cards almost exclusively, but never carry a balance.
I agree that your Roth IRA should not be your main emergency fund. The market is not stable enough to depend on for times of emergency unless your money has been in there a long time and has earned a lot.
That said, I keep a few thousand in savings accounts but have used my Roth IRA as a backup emergency fund in case of major repairs on the house or car. When my son smashed the front end of our van, I took some out to cover that then replaced it over time. After going through a bunch of time and money getting ready for a refinance, I was told I needed to pay off my car–my only consumer debt–so I cleaned out the contributions in my Roth and paid it off. I’ll be working to put the money back in every month with my lower house payments.
So for me having a Roth as a backup emergency fund has worked out well. I still have $20,000 in earnings left in the account that will sit there tax-free for 17 more years. I’ve also heard Suze Orman talk about using a Roth as a method of saving for college, which isn’t a bad idea. FAFSA doesn’t take retirement funds into consideration when determining financial aid qualification, so it’s not a bad idea. I would recommend taking a year’s worth of college expenses out before the actual college date so you can time the market a little better, but it’s worth thinking about as long as you have some other emergency savings somewhere with less volatility.
While a Roth IRA is most certainly NOT a good place to store an emergency fund, I don’t actually think it’s that bad of a place to store a first-time home downpayment. After 5 years, it can be withdrawn without tax and without penalty. Not bad!
I like to keep my Emergency Fund in a Fixed Term account where it is earning profits. The account has a 12 month term. If I do experience any emergencies I use credit cards which have a 12 month interest free period. I just keep paying the minimal interest and then when the 12 months is over I pay it off in full because I’ve made a withdrawal request when I had the emergency.
Prepaid debit card? That sounds a little too risky for my taste. All it would take is for someone to steal your purse, and you could say good-bye to that emergency stash.
When I was working, I always had three emergency-savings stashes:
* A short-term savings account in the credit union: enough for surprises in the $2000 to $3000 range. This could be withdrawn without incurring a tax liability.
* A money market fund at Vanguard: enough to cover a pretty large unplanned expense. Tax on withdrawals from this would be very low.
* A short-term corporate bond fund at Vanguard: several tens of thousands of dollars; combined with the other two, enough to cover something verging on catastrophic.
Everything else resided in IRAs and a 403(b).
Now that I’m retired, it’s all one giant emergency fund. 🙂
Thank you for sharing Vicky!
— Katie
I prefer to use a ladder of Series “I” bonds. They are not liquid for the first 12 months, so I ladder 25% of my emergency fund every 12 months. I never had less than 75% of my emergency fund liquid. Now my entire emergency fund is indexed to rise with inflation.
The withdrawal of Roth IRA contributions is not taxable. Not sure where the information originated but it is WRONG!
Hi Daniel,
Withdrawals from a Roth IRA can be taxable in certain circumstances per IRS. Here you go: https://www.irs.gov/publications/p590b/ch02.html#en_US_2015_publink1000231057
— Katie
The author is 100% incorrect on Roth IRA withdrawal rules. Roth IRAs have FIFO treatment – first in, first out. All money withdrawn that is less than the maximum contributed amount is considered principal (basis) and is thus not taxable. There is no pro-rata distribution from a Roth IRA. The author is confusing Roths with traditional IRAs that have basis (post-tax money).
You lose all credibility when you make statements like that.
I currently keep my emergency fund in a CD. I put $10,000 in it three years ago, and every year it gets automatically renewed. It’s nice to see it grow, it’s even better to know that I never had to touch it since I set up the fund (knock on wood.)
Great post!
I did a withdrawal of $3000 of my Roth IRA basis last year. Taxes due? $0.
nah, I have an entire years income available in credit for emergencies, and I can take my sweet time getting withdrawing my basis money from the Roth. In the last 5 years I haven’t needed my emergency funds, and that is 5 years at 10% growth over 5 years at .016% growth I would have made in savings.
Whomsoever say anything, An emergency fund of covering atleast 6 months of expenses is a must for anyone. I once had situation Where I had to wait for six months to get a visa for an internation job. I was living pay check to paycheck. I was spending money from my own savings account (This was not that emergency fund) for food, house rent, for paying Home loan EMI.
Eventhough you are in debt, emergency fund should include all your next 6 months expenses like debt repayment, basic living expenses, etc. If you have well prepared budget you will have a clear understanding how much you will need.
Also you have increase the fund amount periodically so that inflation on the expenses are taken care off.
Having a plan to cover emergency expenses is essential. I lived with my parents rent-free for two years after starting to work and saved a nice sum. I’ve never had to stress over an unexpected expense since.
Still, I’m not sold that an emergency fund has to be 3, 6 or however many months in an online savings account. I’ve heard of some people using a Roth for an emergency fund. If you have a good sum in taxable savings accounts do you really need an emergency fund in cash? If you have high-interest debt, what’s the benefit of holding cash in a savings account for an emergency?
Having a plan is great. Just remember that all the experts out there may or may not be giving advice that’s ideal for you.
Hi Jason,
I would say that the point of an emergency fund in a case where you have high-interest debt is so that you don’t add to that debt to handle a curveball that life throws at you, or tap into your retirement savings and pay penalties.
For example, a friend of mine who was working on having a cash-only spending plan to pay down debt froze her CC in a glass of milk to prevent any impulse buying, and anything beyond the amount in her e-fund would wait until it thawed out. Her e-fund took care of a car repair (new clutch) that went beyond normal maintainance. Because of her e-fund she got to keep chipping away at her debt without having to add to it.
We have a two-tier emergency fund. The first tier is 1 month of expenses in a savings account at the same bank that we have our checking account. It’s easily accessible money in case we need it. The second tier is our Roth IRA which has close to 10 months of expenses. We consider our ROTH the emergency fund of last resort. Last year, we found ourselves dipping into the ROTH when my income dropped dramatically. We would have been in a world of hurt without it.
We have 3 months of expense in the bank. We never had to dip into it so it’s not huge.
We also have about $400,000 in bonds. That would be enough to fund our lifestyle for years.
I think having the bond cushion is a great backup. We should be able to sell it even when there is a recession. What do you think?
That probably depends on what bonds you have and what their length is. Also what all you included in expenses(some people just include debts/rent and forget other necessities such as food). It also depends if the bonds have coupons or not as then this cash flow can help until the maturity date.
Again hard to know without other details is this 10%,90% of wealth. These next statements will largely depend on risk tolerance.If this is most of your savings is this 400k it isn’t great because you are basically losing money in all events except a recession-type event. This is because you will earn less than inflation on bonds. On the plus side, you take away worry and you are almost 100% sure you get your money. If this is all savings I would probably sit with a fin advisor or if you have time read some books and determine what mix would be good for you. I bet you could do some better investment mix that would still leave you protected but, also gain some value. Also on the bonds, I wouldn’t stick them all in 10 years. I would split in different increments in general(though I may keep many short term 1-2 years because interest rates are likely to rise soon.)
In our house we call this the Oh $hit fund, on the grounds that it’s what you say when you realize you’ve got a big bill coming your way that insurance may not cover, or only partly covers.
My goal is 1 year of salary saved and my rate of savings is the largest car payment I can comfortably make.
That number is fortuitious because the last two times I’ve tapped it was to buy new cars! The first time when I totaled my car in an accident, and the second time 6 years later when I re-injured my back and discovered that I can no longer easily get in and out of a sedan/coupe on most days and needed a car with a higher ride height.
In both cases, the Oh $hit fund enabled me to pay cash for my cars.
Fingers and toes crossed, I’ll have the fund fully funded by the end of this year & will then put the money towards increased contributions to my 403 and HSA!
There’s often a rush to start investing towards retirement and other goals without considering an emergency fund. But a properly funded emergency fund is indeed indispensable. You never know when life will throw you a curveball.
For some reason I refer to my emergency fund as an “e-fund.” I don’t know if anyone else does this. Also, the few times I could’ve used it for an emergency, I try to use my regular income instead and not touch it. I guess I’m funny that way?
I’m of the mindset that some of those emergencies aren’t really emergencies. Car repairs happen pretty regularly if you own a vehicle of a certain age. Every year, I set aside the average amount I’ve spent on car repairs in the last 3 years. If the car repair is more than 3-year the average, then that’s definitely a good use of my emergency fund. Realistically, though, I spend roughly the same amount of money on the car every year. Budgeting for irregular (but predictable) expenses has been what allowed me to make progress on an emergency fund after years of putting money in, taking money out, putting money in…
Totally agree. As I was reading the article, I was thinking of my recent “emergencies”: replace tires and brakes, fix stuff in the house, backyard landscaping “emergency” (per my gardener!).
I set aside a couple of thousand dollars per year for these types of emergencies and, if I’m lucky and I don’t need to use the money, I donate it to my favorite non-profits.
Also, I don’t know what to think about setting the fund in a savings account vs. just having it simply invested in a diversified portfolio. The immediate answer may be that a savings account is preferable because one may have an emergency during a market downturn but it is probably better to understand the probability of both events occurring simultaneously.
Even though I keep around six months as a cash emergency fund, my first level emergency funds have always been credit cards. If I have high expenses coming up, or an expected reduction in income, I take out a new card with 15 to 18 months interest free, or sometimes credit cards I already own offer free balance transfers (a benefit of keeping a credit score over 750). Why drain my cash when I can spend someone else’s for free. I save cash earmarked for paying off the debt, and only use the cash emergency funds if I can’t save enough to pay the debt off from savings by the time the promotions expire.
I haven’t had to use my emergency fund in almost 10 years, even when I was unemployed for six months, and did a whole house renovation. Taking out long term credit card “loans”, and diligently saving money to pay them off, has kept me from need big to use my efund, and it’s earned me several thousand of dollars in rewards and interest.
Timely article – we’ve finally gotten to a point where we have a large enough emergency fund (4 months living expenses) and it’s just sitting in an online savings. It hit me the other day that I should probably put a chunk of it in a Roth, correct? Even though I’m in my 40’s, I understand I can withdraw the contributions for emergencies if needed without penalty.
It’s all about peace of mind. Several years ago I totalled my car and I remember the insurance agent saying, “you’re fully covered, a rental is covered, but there is a $500 deductible you’re responsible for. ” I replied, “That sucks, but okay, not a problem.” I didn’t even realize what happened until hours later: I had a huge problem that morphed into a simple inconvenience all because I could cover the expense. I slept like a baby that night. Sometimes $500 feels like $5 million but with steady diligence we can all have an emergency fund.
I would add: if youre tapping your e-fund more than once per year you probably have a problem with your budget. Car repairs, home repairs, and many other situations aren’t emergencies but irregular expenses. Be sure you’re ready for them.
I’m a numbers nerd and i have a dozen categories in my bugdet that aren’t bills including car insurance, propane, clothes, and summer activities for my kids. I send my budgeted amount off every month to a separate savings account then transfer it back when i need it.
But that’s all separate from my emergency account.
As a numbers nerd I also have a pared down emergency budget. I know just what bills I would immediately cancel if I lost my job. I also don’t keep a specific emergency account persay. I have $3k that I tap for short term things. But beyond that it’s more that I know what I would liquidate and in what order. For example the savings account for irregular expenses would go first. Then other cash, then bonds, etc. Once you have assets they’re ALL your emergency fund. It just depends on how desperate your emergency.
Great reminder – timely also with the government shutdown meaning that tons of people (even if it was just a few days) were out of work.
Personally I keep mine in an online savings account for two reasons – higher interest and because it’s out of reach being a step removed from my regular bank.
Thankfully haven’t had to dip into it but if I ever needed it, it’d be there to help!
I had just gotten to the point of having 3 1/2 months in my Rainy Day savings account. Was thrilled with my money sitting there and along came Hurricane Irma. The thing with homeowner’s insurance I learned is even after you pay the deductible there are still costs that I had to cover. My insurance covered almost $10K roof, wall, fence and only the part of the trees to get them off the fence. My part was $7K to get all of the downed trees out of my backyard and I have excellent homeowner’s ins company. What I am pondering is keeping only a month’s worth of expenses in interest savings account. And the rest in Vanguard Life Strategy Fund of 80/20 bonds to stocks. With this, I can keep a little ahead of inflation but still have the flexibility of getting to my money in case of emergency.
Im thinking about having precious metals as emergency fund for Emergencies with capital E. For example gold bullion. That is something totally separated from the bank system and national currency. I dont mean a fantastic hidden treasure.
We also have 5000 USD in bankaccount plus credit cards.
I was having a really crap time at work. I had 99% of my savings in ETFs and funds towards the aim of FI and it actually made me feel really trapped as I hate selling other than for rebalancing, but I have another 2-3 years for FI.
I persevered in the job but I learnt the lesson. I’ve now got 1.5 months’ salary in cash and aim to increase it further by the end of this year. Just this small amount gives you a lot of peace of mind. It’s essential but seemingly often overlooked.