What is the minimum amount to hold in an emergency fund you require before feeling comfortable? I use to think 20k was a good number. Lately, I've been kinda feeling the itch to take some of that money out to invest. In a way, I don't like holding so much cash knowing it won't be generating any interest / returns. Then again, with all this talk about the markets collapsing and what not, there is a certain peace of mind that comes with hoarding cash. Thoughts?
Emergency Fund(18 posts)
My thoughts: in your emergency fund should be the amount of cash that you want to have availabe in case an emergency happens; and you must accept that you can't make big profits with it (maybe even lose a bit of value every year due to inflation and the interest rate not matching up).
You are weighing the (big, big!) advantage of having cash available at the sudden event of a financial emergency against the disadvantage of the money just sitting there doing nothing for now.
It depends, I guess, on how much risk you're willing to take (risk-aversive people won't mind so much that their emergency fund is large and just sitting there) and on how much money you'd need in case of an emergency. And even also, on how easy it could be for you to borrow money in case of an emergency (credit card / line of credit) and on how easy it would be for you to pay that borrowed money back / refill the emergency fund quickly.
I really don't think there is a calculation to get the perfect amount of money for an emergency fund. It's all about westimating risks and consequences...
there are some good unconventional posts on ere and mr money mustache on this topic. definitely check that out.
-i think most personal finance folks emphasize the need for an emergency fund because MOST people don't save much if at all and when something unexpected comes up, they end up in terrible financial situations. for those of us that don't have issues with saving/living below our means, that means we aren't lacking in funds and/or abilities to leverage our way into handling these emergencies.
in your case, you have saved a good sum. obviously investing part or all of this fund is going to add risk, and no one can answer the question for you regarding how much risk you are comfortable with and how much of that emergency stash you are willing to part with if you lose some of it.
access to credit, funds being somewhat easily liquidated from investment accounts within a few days/weeks, insurance, etc can make it overkill to hold so much in emergency funds.
for my case, i hold 3 months BARE MINIMUM living expenses in a savings account and the rest will go into my investment accounts. i have great credit and access to credit as well as a stable paying job to handle paying that back.
i have no dependents or mortgage or debt, so things are simpler for me. a lot of people have more complicated scenarios, though.
I would agree with Dutch Girl. Somewhere between 3 months and a year's worth of expenses might give you a ball park to be in, but this is definitely not "one size fits all".
Also, if you have access to a credit line, you may need less cash for true emergencies. For some the solution is pay down the mortgage and keep a credit line in place.
From an investing perspective keeping some cash around during relatively normal market conditions is usually a safe position, because it allows you to take advantage and buy when the market tumbles. Basic Warren Buffett/value investing type strategy. But you would have to balance that idea out with whatever else it is that you currently own.
I am comfortable going as low as 1-2 months of expenses in a checking account. That, coupled with an ample limit on my credit cards, provides enough time for me to liquidate other investments should I need money.
Honestly though, I've never had an emergency that even emptied my checking account. Given that I also save 1-2 months expenses every month, it's pretty tough to overflow that buffer.
I think the size of an emergency cash reserve depends on how much you have in liquid taxable investment accounts and contributions to your Roth IRA.
For instance, if you have at least a years worth of living expenses in taxable brokerage accounts, then you are in good shape compared to someone who has none. If the market crashes 50%, you still have 6 months worth. Market freezes (think Sep 11, 2011) and natural disasters (tsumani?) might delay getting to such funds, but they are rare events and not likely to keep you from your money more than a month.
It takes a few months before creditors will take drastic action. You can skip paying conventional phone bills (not prepaid), water, sewer, etc. a month or two. Rent is not something to be skipped, but there's probably more forgiveness in a mortgage. Property taxes on a mortgage-free property can be skipped for a couple years. Yeah, that damages your credit, but if the choice is damaged credit or bankruptcy, which is worse?
Paper savings bonds are an emergency fund, too, as Katrina victims can attest. Now that they're no longer available and you can only buy electronic records, I have slightly less faith in using savings bonds as an emergency fund... am I being old-fashioned?
So... I have 4+ years of living expenses available in taxable accounts (having about 3 years worth of unused margin!) and Roth IRAs. There's usually a month's worth of expenses in the checking account and at least a month's worth of expenses in the savings accounts. On top of that, I have a month or two worth of savings bonds. The taxable accounts currently generate 30% of our living expenses (that we're not drawing down).
In many ways, that all seems like overkill.
My goal is to have a year's worth of living expenses and all of my insurance deductibles in cash (i.e., in checking and savings accounts). There are high-yield savings accounts available online where the interest rate is greater than 0.5 percent. I'm about half way there in terms of reaching my cash-stash goal.
For the rest of this amount, I'm considering higher-yielding alternatives such as a low volatility bond fund.
I also have credit cards to use in an emergency and I've done so in the past. Normally, I pay my balances in full each month, but I have taken a year or two to pay them off when I had an emergency to cover.
Here is a recent article in SmartMoney Magazine that discusses this topic: http://www.smartmoney.com/invest/strategies/fatten-your-reserves-1331654002743/
I have no taxable accounts, so I keep about 10-12 months in our emergency fund (.8% online savings). DW is a stay at home mom so our risk exposure is pretty high. It prevents us from investing that bit, but its worth the safety knowing we could go quite a while before needing to liquidate 401s/roths/home equity (which all come with other costs).
It also may be useful to shop around for a savings/checking account that gives good interest.
Our credit union gives 3.25% on checking account up to $25,000, with the criteria of using its debit card 20 times a month.
I have stuck with a year's worth of expenses because it could easily take me a year to get a new job, due to licensing, non-compete clauses, and a small job market for my skills.
Logically thinking a year is overkill- most of the things I invest in are reasonably liquid in most circumstances-- stocks and mutual funds can typically be sold in one business day if needed.
One thing that is helping erase this is that my current job has a 457 plan-- so far as I understand it, I can take money out of the 457 plan at any time, I just have to pay income tax on the distribution-- but that's true no matter when I take the money out.
As I think about this now... well is it wise to raid the 401k or 457 if the ship is sinking? Money in those plans is protected from creditors, so you won't lose the money, even in bankruptcy.
> As I think about this now... well is it wise to
> raid the 401k or 457 if the ship is sinking?
Ah, yes, you've hit one of the questions of what is an emergency fund used for? And I think the answer of how big the emergency fund should be and what form it takes will depend on what the expected use is.
The first use most people think of is, "how will the bills get paid if I lose my job?". Second is usually "how do I pay a big bill, like an unplanned hospital stay, vehicle replacement, home repair, or get myself bailed out of jail?" The final emergency fund use goes along the line of, "natural disaster or war or bank holiday has disrupted normal services, so how do I pay for things when the usual avenues of credit aren't available?"
Are you trying to protect assets in case of potential bankruptcy, keep your home from the mortgage company, avoiding moving from a good rental, or are you just trying to keep a good credit rating? Are you thinking about the possibility of traveling unexpectedly?
I think Jacob's blog post is worth revisiting:
You got some risk of jail time, Georgie? ;-) You know I'm a lawyer . . .
Covered in chapter 7.
It's pretty simple really.
What's the frequency of the emergency?
What's the maximum cost of your emergency?
How many months does it take to pay for that after all needs have been met?
The answer is very different from a consumer who spends practically everything he earns (he should have a large amount to cover large expenses) and thus saves very slowly (he should have many months of savings)---this situation is made more tenuous by the reliance on a single source of income ... and an ERE who spends little (probably doesn't have to pay a lot when things break) and thus saves most of what he earns (maybe he saves 5 months of expenses in a single month if still working) and whose income is diversified.
Also, a regular worker/consumer will have most/all of his savings in a retirement account which is hard to liquidate. It's not uncommon for consumers to handle emergencies with credit cards that then get paid off by liquidating the 401k and taking the penalty. Since ERE is an entirely different universe, the normal rules don't apply. If I have a big emergency, I just sell a few hundred shares of an underperforming stock and write a check.
If it comes to economic breakdowns, an emergency fund is not going to be tallied in money ... in that case it's more a question of how much food and water you have on hand. (It's a good idea to have at least 6 weeks of food in the pantry.)
I used to keep my emergency reserve in the form of investments in a diversified portfolio of publicly-traded (i.e., liquid) stocks. If I ever need to raise cash to cover an emergency, I would selectively sell some shares to do so.
Then the meltdown of 2008/2009 happened. The market value of my portfolio tanked (it has since recovered) and I was getting fewer billable hours for awhile. So I decided to keep my emergency reserve in the form of cash and low-volatility investments that would hold up relatively well under large market swings.
The long-term return I give up by using this approach is more than made up for emotionally by getting a good nights sleep in the short term.
When I liquidate investments to raise cash, I want to be able to decide when to do so (i.e., when the market is going up rather than going down). Having to sell during an emergency to raise cash means the market is making the sell timing decision for me, which is not always to my best advantage.
Thanks for the replies and great tips everyone. I have been thinking about where to store my emergency fund for awhile now. So far, I'm just keeping it a savings account earning minimum interest. I like Jacob's idea of using a credit card to cover the initial costs, while using the grace period to transfer over funds.
The idea of keeping it in stocks is intriguing. That way your emergency fund can be utilized to gain returns. This is a route I am considering. Though Cashflow brings up some very good points, and highlights my main concern - another 2008 / 2009 market crash that will vaporize not only my portfolio, but emergency fund.
A good compromise might just be that, a blend of stocks and cash. For stocks, housing in ones that have low beta and are less reactive to market fluctuations. Utilities are a sector that immediately comes to mind. High yield and relatively low risk.
"Lately, I've been kinda feeling the itch to take some of that money out to invest. In a way, I don't like holding so much cash knowing it won't be generating any interest / returns."
I understand the sentiment, but also consider that when you are making decisions on finances, you must try to leave the current financial paradigm alone and think differently. People have been trained to be yield seekers due to a 30 year inflationary environment. This could repeat for another 30 years, but it may not. When sovereign first world states are going bankrupt, this does not portend well for inflation. It may represent the end of net debt expansion, and instead point to a deflationary cycle where falling marginal collateral values lead to the extinguishment of debt. In this environment, CASH earns you relative return against falling asset values, and is a great thing to have on hand - and not necessarily just for a crash.
Yes, some argue that governments will print their way out, but I would suggest that they are trying this now without much success. So don't FEEL an itch, and herd with the rest. If you want to be different, you need to think different.
It depends on your spending needs and your risk.
I'm over-conservative, but I use a five-year CD ladder for liquid, emergency funds. It would cover ~70% of my living expenses for five years.
The largest risk I see, is being unemployed/disabled long-term at the same time equities tank. (Who wants to sell their nest egg at the bottom of the market?)
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