If there’s one thing that’s the forgotten step-child in personal finance, it’s the emergency fund.
Those just starting out on their financial journey hate it because it’s a killjoy — something they have to save for that has zero perceived value (at least in many people’s minds).
Those of us further down the road don’t really think much of it as it’s simply “there” — it’s not really a vital, active part of our money plans.
But then a global economic crisis comes along and all of a sudden the lowly emergency fund becomes the star of the show.
That is, if you’ve kept it safe and sound all these years.
I thought it would be interesting to take a step back (for most of us) in our financial journeys and have a little chat about emergency funds.
What is an Emergency Fund?
I can’t imagine many ESI Money readers don’t know what an emergency fund is, but just for grins, let’s look around the web at a few definitions.
Let’s begin with Investopedia:
An emergency fund is a readily available source of assets to help people navigate financial dilemmas, such as the loss of a job, a debilitating illness, a major repair to home or car—not to mention the kind of major national crisis the coronavirus pandemic has created.
The purpose of the fund is to improve financial security by creating a safety net of cash or other highly liquid assets that can be used to meet emergency expenses.
It also reduces the need to either draw from high-interest debt options—such as credit cards or unsecured loans—or undermine your future security by tapping retirement funds.
Here’s how Vanguard defines it:
An emergency fund is a stash of money set aside to cover the financial surprises life throws your way. These unexpected events can be stressful and costly.
Here are some of the top emergencies people face: Job loss, medical or dental emergency, unexpected home repairs, car troubles, and unplanned travel expenses.
Dave Ramsey, king of the emergency fund, defines it as follows:
An emergency fund is simply money you’ve set aside for life’s unexpected events. We’re talking about true emergencies here, like a car wreck, a hospital visit or a leaky roof.
Bankrate keeps it short and sweet:
An emergency fund is an easily accessible savings account intended to help pay for unexpected expenses.
And NerdWallet does as well:
An emergency fund is a bank account with money set aside to cover large, unexpected expenses, such as unforeseen medical expenses, home-appliance repair or replacement, major car fixes, and, costliest of all, unemployment.
Ok, so it’s pretty clear: an emergency fund is a stash of (usually) cash for unforeseen financial emergencies.
These “financial emergencies” are not in your budget and can be difficult for many to fund out of current earnings, especially if their budgets are tight.
This is exactly why most people need emergency funds, isn’t it?
Why Do You Need an Emergency Fund?
If the above didn’t answer why emergency funds are vital, the following quotes should do the trick.
Here’s why you need an emergency fund according to Dave Ramsey:
The reason to have an emergency fund is simple: You don’t know what’s going to happen. And no one wants to live at the mercy of life’s twists and turns. Your emergency fund will come in handy if you suddenly lose your job or your HVAC breaks in the dead of winter. Don’t let yourself be caught off guard! You need that safety net between you and life.
Here’s NerdWallet’s take:
Emergency funds create a financial buffer that can keep you afloat in a time of need without having to rely on credit cards or take out high-interest loans. It can be especially important to have an emergency fund if you have debt, because it can help you avoid borrowing more.
Vanguard goes a bit deeper with the following:
Aside from financial stability, there are other pros to having an emergency reserve of cash.
1. It helps keep your stress level down.
2. It keeps you from spending on a whim.
3. It keeps you from making bad financial decisions.
In short, life happens. Unexpected financial emergencies come up all the time — it’s part of life.
An emergency fund is simply preparing for these emergencies in advance by setting some money aside. You save money in the present knowing that when emergencies pop up (and they will) in the future, you will be able to cover them.
How Much Should an Emergency Fund Cover?
What size should your emergency fund be?
Lots of consensus here…
From Vanguard:
In a nutshell, you should have at least 3 to 6 months’ worth of expenses—but the exact amount depends on a few variables.
NerdWallet’s take:
The short answer: Up to half a year of expenses.
The long answer: The right amount for you depends on your financial circumstances, but a good rule of thumb is to have enough to cover three to six months’ worth of living expenses. If you lose your job, for instance, you could use the money to pay for necessities while you find a new one, or the funds could supplement your unemployment benefits. Start small, Weston says, but start.
And from Investopedia:
Financial planners recommend that emergency funds should typically have three to six months’ worth of expenses in the form of highly liquid assets.
Dave Ramsey gets a bit more specific:
If you have debt, I recommend saving a starter emergency fund of $1,000 first. Then, once you’re out of debt, it’s time to beef up those savings and build a fully funded emergency fund of three to six months of expenses.
A couple comments on these points:
- I like that every definition focuses on expenses. Many times you’ll see very general, income-focused advice given in money matters like “You can live on 80% of your income in retirement.” Really? What if I live on 50% of my income now. Does that mean retirement will be more expensive? Why not focus on the expenses I have to gauge what I will need to live on? It’s just a rule-of-thumb that’s off a bit. So I like that every site is focused on expenses here.
- Why three to six months? Why not just three? Or why not just six? Or why not four or five months? It seems like a range without any specific reason for it.
Personally, I like six months’ worth of expenses because it has a buffer built in for an extra margin of safety. And you know how I like margins of safety. 😉
Where is this margin of safety? Let’s say you have what’s probably the worst-case scenario for an emergency fund, a prolonged period of unemployment. You could immediately lower or eliminate your non-discretionary expenses like eating out, entertainment, travel, and so on. This way, your six months’ of normal expenses saved might last you seven, eight, nine months, or longer!
As you’ll see below, our “conserve every penny you can” plan is half of what our regular spending is. So if we’d buckle down, our emergency fund would last twice as long as it would under normal spending levels.
How Important is an Emergency Fund?
Ok, let me finally get to the point. I’m writing this article because I wanted to emphasize the fact of how important an emergency fund is.
If we didn’t believe it before, we certainly do now as we’ve seen the need for extra savings play out in front of our eyes.
The federal government had to send most Americans $1,200 because they didn’t have adequate emergency funds (at least this is part of the reason). Otherwise, why would so many need a handout after a week or two of isolation/not working (When the checks were originally being called for. Oh, and BTW, many were still working then and yet received money — don’t get me started on that)?
But don’t take my speculation for it. Let’s look at a couple posts addressing how much Americans have saved for an emergency.
Here’s Vanguard’s take:
56% of people in the United States don’t have a rainy day fund that would cover 3 months of expenses.
Let’s rephrase this:
A majority of Americans don’t meet the bare minimum requirements for an emergency fund.
On the other hand, 44% do have enough to cover at least three months — or at least they did. More on that in a minute.
Here’s some information from CNBC that gives another perspective:
Almost half (41%) of Americans can handle a $1,000 emergency, such as a medical bill or car repair, by dipping into savings.
Another 37% say they would use a credit card, take out a personal loan or ask family for financial help to handle unexpected expenses, according to a new poll from Bankrate of over 1,000 U.S. adults. Only about 3% of respondents say they don’t know how they would handle a $1,000 emergency.
That’s in line with other research. Last year, about 61% of American households said they would pay for an unexpected $400 expense with cash, savings or a credit card, the Federal Reserve found. About 12% said they would not be able to cover the expense at all.
But Americans’ emergencies, on average, cost more than $1,000, Bankrate finds. The average unexpected expense for survey respondents was about $3,500. And these situations are not uncommon. Within the past year, 28% of people experienced a financial emergency.
These numbers actually make Vanguard’s look good. The difference might be what’s happened in eight years. Vanguard’s numbers are from 2012 while CNBC’s post was written in 2020.
If 41% can handle a $1,000 expense, how many can handle a $3,500 expense? Probably very few. 20% maybe?
Let’s look at it another way. $3,500 is probably about a month’s expenses for the average American (give or take a bit). That means very few — maybe 20% (or even less) — have enough to cover a month’s worth of expenses.
Even if it’s two months’ worth, the point is still valid — Americans don’t have much in their emergency funds, and this latest economic problem has highlighted this fact.
I wanted to see if I could find more specific information (or at least additional information) and Googled a bit more.
The first article I discovered was this by the NY Times:
Six weeks of take-home pay.
That’s how much cash families should aim to set aside to ride out gyrations in their income and expenses, a new analysis from JPMorgan Chase’s research arm finds.
The recommendation, based on an analysis of millions of Chase checking accounts, is considerably less than the traditional rule of thumb of three to six months of take-home pay.
But even so, most households fall short, the report found: About two-thirds lack the recommended buffer.
To cushion against a simultaneous spike in expenses and dip in income, a middle-income family needs about $5,000 in a rainy-day fund but has just $2,000 — a gap of $3,000. Lower-income families need about $2,500 but have just $700.
The AARP found that more than half of American households (53 percent) lacked an emergency savings account, including a majority of people over age 50.
Lots to comment on here:
- Uh no. I hate “six weeks of take-home pay.” First, it focuses on income, not expenses, just the sort of nonsense I was talking about above. And second, it seems way too low. I’m sure the study is sound mathematically but somewhere it went off the rails IMO.
- Even with their lower amount, “about two-thirds lack the recommended buffer.” In other words, about 67% don’t even have six weeks of take-home pay. This is making my “20% don’t have an adequate emergency fund” estimate sound pretty accurate.
- The study’s problem might be that it looked at emergencies that were mostly blips here and there. Sure, six weeks take-home pay might cover a small car accident or a washing machine breakdown, but what about unemployment (when income is ZERO and expenses still exist)? Six weeks of funds is not going to cut it then.
- They are estimating the six weeks to be equal to $5k. That’s $833.33 per week. If you put that in three and six month ranges, that means an emergency fund should have somewhere between $10.8k and $21.7k in it. That last number is so very close to my one-month estimate of $3,500. Am I good or what? 😉
- From AARP we know that over half of Americans have no emergency fund at all. Tack on those who have an inadequate emergency fund and a large portion of the public are in for a world of hurt should an emergency arise.
Moving on, I found this Bankrate quote which got right to the point:
Just 18 percent of Americans say they could live off their savings for at least six months. That’s the lowest percentage of people with an adequate savings cushion in nine years of conducting Bankrate’s poll.
I promise you I wrote the top portion before I found this number. Turns out my 20% guess was right on! Haha!
So, it’s bad.
Now, what should be done?
IMO not much more than what should have been done to begin with. I’d recommend Americans saving six months’ of living expenses as soon as they can.
I understand it might be tough to do so right now, but once the clouds clear and things are back to at least somewhat normal, they should get to work on this right away.
A house is only as good as its foundation and the emergency fund is the foundation of every person’s finances.
My History with Emergency Funds
I have a unique history with emergency funds.
I always had one, almost from the start of my career.
I saved up six months’ worth of expenses and sat on it for many, many years because I didn’t need it.
It wasn’t because we never had emergencies but because the gap between our income and expenses was so large that we could cover emergencies out of cash flow. Thus we never needed emergency funds.
When I retired, things changed a bit. Since you have less room for error when you aren’t working, I increased my emergency fund.
My cash account (of which my emergency fund is a subset) grew over time but that was mostly by accident. I made more than I spent and sold a business. And there weren’t great investment options, so cash accumulated.
Then I allocated some to private loans and bought some dividend stocks.
Now my cash is “down” to $250k.
Here’s how it breaks down:
- $100k is my true emergency fund that I don’t want to go below. This represents roughly a year of expenses at our current (rather free-flowing) level of spending. It’s 2+ years’ of expenses at what we could spend if we tightened our belts.
- The rest of the money is set aside for two things — to seize extra investment opportunities that might pop up and to help my daughter and son-in-law buy a home when they move to Colorado later this year (how much we’ll help them is TBD, but it will most certainly depend on how much they help themselves.)
The other issue we have is that we are still spending less than we earn. In my 2020 financial forecast I estimated we’d have income of $130,090 and expenses of $91,310, so that alone creates an extra $40k of cash each year.
Now with the economic issues the world has had, my guess is that both those will go down (we’ll earn less but also spend less), but even in a worst-case scenario we’ll likely have a significant gap between what we make and spend, thus helping us to pay for many emergencies (like me needing a crown) out of our cash flow.
So those are my thoughts on the ever-important emergency fund and how we handle ours.
How about you? How much do you have saved in your emergency fund?
Razorback 14 says
Thanks again! Very helpful.
7 months to retirement—-
I’m going to shoot for all debt to be paid by 2021 and I’m going to try to reach the following:
1. $120,000 – emergency fund
2. $150,000 – investment opportunities
3. $30,000 – Travel expenses fund
$300,000 Total – about 1/2 there now.
Debbie says
I calculated my Emergency Fund the lazy way. I just took my net income x 13 paychecks and got the goal amount. It has been sitting there in a 1.5% Money Market. Then I started another sorta Emergency Fund for things that go wrong during the year. You know, sudden house repairs like dishwasher dying in January. That fund currently has almost 2 months of my net income. For fun I ran the numbers of true emergency lockdown mode and I have almost a year put away. It gives me peace of mind in these times. Life is life and something eventually will happen be it Covid-19, monster old trees down in a storm, damaged roof needing repairs, the car is totaled, loss of a job, scary medical issue, etc. Something eventually will happen but that money sitting there is my peace of mind when Life does happen.
Bernd Doss says
Thanks for this post. I have been drilling this issue down to my children and grandchildren for the past several years, and the current pandemic situation has made an emergency fund more important than ever. Personally, I use expenses that are “real” to calculate the amount of money that the emergency fund will need yearly to sustain itself. Plus I automated the deposits in the event I become mentally disabled. The fund uses a money market checking account at my bank and even though the interest rate is not enviable, the fees are very minimal and balance each other out. Actual amount of one years expenses is the amount held in that emergency fund, excess cash is used for investment holdings purposes. Periodically the fund is reviewed and adjustments made for inflation.
Ron says
My dad was old school.
When I was a kid, he used to say, “I don’t know how some of our neighbors sleep at night because if their water heater would break tomorrow, they don’t have the $$ to buy a new one.”
That stuck with me. I’m now 52. I’ve had an emergency fund from the the day I started working at age 13.
Today, my emergency fund is flush with cash. And, I don’t worry (ever) about replacing the water heater (or anything else frankly).
Thanks Dad!
Perry says
Very cool story Ron, thanks for sharing!
No longer hot in FL says
I had no choice but to replace my AC last week – a nice $6k bill. How was I going to pay for it? I could take out a loan through the AC at 9.99%, charge it or pay cash for it. I charged it. I’ll get my reward points and then pay for it in full from my emergency fund. An emergency fund for me creates a stress free life. I would have loved to have used that $6k for something other than an AC, but as your article reminds me, life happens and I’m prepared!
Xrayvsn says
I used to be cavalier about having an emergency fund. I would have a savings account with money accumulating that was a pseudo emergency fund but would deploy it when some investing opportunity presented itself (such as real estate) and repeat the process thinking I could rely on my physician income to tide me over if something popped up.
I always hated the cash drag it created and therefore did not give it much priority
I was very fortunate that I had over 6 mo living expenses when the pandemic hit in this account and it then allowed me peace of mind.
Jonathan says
I could have written this comment almost word for word (I’m not a physician though). By happenstance, we had over $100k in cash in March – primarily because we hadn’t found any good investment opportunities lately.
Because we have a big gap between earning and spending, and our w-2 incomes have been uninterrupted by the pandemic (our investment incomes have dropped though), and our expenses have dropped over the past couple months, our cash position has continued to grow during the pandemic, but I’m glad to have it as a buffer anyway.
M says
Sitting on 1 year’s worth of cash expenses in our low-yielding (or is it “no-yielding”?) checking account, a little over $80k. With strong cash flow from two dissimilar careers, this is up from our usual of $30k, which I have always thought of as conservative for us.
Like others, I have always had “rainy-day” cash, as I like to call it, since I was a teen. I don’t know how people can sleep without it.
I have always thought that the benefit of having cash like this is that it teaches you that just because you have money, you don’t need to spend it. It is sort of a chicken and egg situation where I’m not sure what came first — the self control or the cash reserve.
Kevin says
This is a timely post having just revisited my emergency fund this past week, I think its also really critical to know what your actual monthly expenses are. If you don’t know that, then everything else is a complete SWAG.
At our current monthly spend rate, we are at about 4 months of expenses covered in an emergency fund but by October because of some expenses/liabilities going away, that will go up to 5 months. I’m self employed and my business is also 45 days net so should something happen on the employment front, there’s another 2-3 months of expense coverage there.
What is interesting about knowing your expenses is knowing what you can and cannot reduce. If 35% of your monthly expense is house and utilities, then you can’t do anything about that without downsizing. Difficult to do quickly. We have dogs. Dogs can be expensive depending on your circumstance. Especially if you need a dog walker which can become the bane of your existence in terms of expense cost. In non-covid periods when I can’t work remote, ours is almost $5k/year. Obviously if you aren’t working..you don’t need a dog walker. But if you are, that’s an expense that is difficult to reduce. Knowing these kinds of things can really make a difference in your view towards the future.
My sweet spot given I am still working, is 6 months of emergency funds in cash and then everything else outside of tax advantaged accounts is invested.
George says
“What is interesting about knowing your expenses is knowing what you can and cannot reduce”
This is what I was going to post. My wife was partially furloughed and was asking if we were okay. We took a look and it doesn’t seem like we need to reduce our expenses yet but if this continued for months we might WANT to just so we didn’t miss out on investing opportunities.
This made me curious about expenses that we cannot reduce. For us that is things like insurance, cell phone, utilities (in fact since we’re home so much our electricity bill is definitely increasing)… but we could tighten the belt on groceries and take out (you know the obvious stuff). So I’m not sure how much our emergency fund is actually good for- on paper it seems like it’s good for several months, but if we tightened the belt where we can it might be significantly longer.
Mr. Hobo Millionaire (MI-149) says
>>Just 18 percent of Americans say they could live off their savings for at least six months.
If only 18% of Americans can live off savings for 6 months, just think how rare it is for people to be 100% financially independent (live off savings/investments “forever”).
Kevin says
Great observation…
Dale Tucker says
I keep one year’s expenses in cash – in a “high” interest savings account. A long time ago I read “The Art of the Long View” as part of a company training course on scenario planning. Had a significant effect on how I go about making more sound decisions. Anyway, I have 3 budget plans: normal lifestyle, then 2 that match tougher economic scenarios: belt tightening and bare bones. I know I can live within any of the 3. Helps me sleep at night.
Mike says
We have 3 months of normal expenses in our emergency fund. However, we could cut out some unnecessary expenses if needed to make it stretch.
We also have other cash reserves but they are for other specific financial goals (real estate, car fund, travel fund).
My wife and I both have secure (or as secure as you can get) jobs that make us feel comfortable with less in the emergency fund. We also have a buffer of roughly $1,500 we can save each month which helps us not tap into the emergency fund for smaller emergencies.
Thanks for the post! Enjoyed it!
BSue says
I have been surprised how rarely we hear about emergency funds during the pandemic. Maybe it is such a painful 20/20 hindsight that most writers fear they will lose readership by saying I told you so.
Our emergency fund is currently sitting at 2 years of expenses in a non-managed money market account for several reasons. We upped it because the stock market seemed overinflated, and we expected a correction. We are transitioning to semi-retirement (Both now self-employed with variable income) and wanted a good buffer in case what we thought we needed and actually needed were drastically different. We are still putting off drawing on IRAs or applying for Social Security. We like to have ready cash for an investment opportunity outside the stock market.
For someone who doesn’t like to have funds sitting around earning nothing, having multiple designated uses for the funds might help them get over it.
Paper Tiger (aka MI-27) says
At the beginning of 2020, I took a hard look at our financial portfolio and made some significant adjustments. 2019 had been such a great year that I felt the need to be less aggressive, assuming a correction had to be around the corner, given how long this bull had been running. I had no idea it would be COVID driven but just felt the need to lighten up on equities, increase cash, and establish more liquidity. With this in mind, we did the following:
1. Sold a couple of mutual funds and bought a $150K CD @2.6%.
2. Put an additional $100K in a High Yield Savings account. We also have $150K in savings bonds paying an average of ~3.25%.
3. Cut our equities position in half and reallocated this to bonds. Achieved this without a tax ramification by moving 90% of our 401Ks from equities to bonds. Asset allocation became 42% Equities/REITS and 58% Cash/Bonds. We have since bought some of the dips and moved back to a 60%/40% allocation of Equities to Fixed Income.
4. Just closed on a $400K Home Equity Line of Credit to increase liquidity and access to funds at a reasonable interest rate.
Making these moves allows me to sleep much better as we slog through what I anticipate to be a long and painful process to economic recovery. I should also note that I am 62 and retired. My wife continues to work and plans to stay employed for at least 5 more years.
Tom says
I quit the world of work two years ago (not calling it retired!), and our plan evolved for my wife, who is several years younger, to quit her job on May 2 of this year.
We set up our “emergency fund” to cover more than just a car repair or water heater. Instead we viewed an emergency to be a bear market and the sequence of returns risk that having one would introduce if it occurred early in our retirement. So two years of full budget expenses are in cash savings and included in our asset allocation calculation. And this could easily be stretched to three or maybe even four years if we eliminated all discretionary expenses.
Then along came COVID, the market crashed in March, and May 2 came and went. Our new emergency fund? My wife’s job! We’re both grateful that she’s been able to keep it given how many people have been laid off.
Interesting times, and timing – glad we hadn’t kept the January 1 date that we first started playing around with.
Phillip says
2 years of expenses for me. I’m an advocate of not having financial stress due to job loss. So we worked hard to pay off the mortgage and keep 2 years worth of living expenses in cash (e.g. “high yield savings” and ultra short-term bonds). In those investments, I keep a minimum of $120k ($5k mo. x 24 months of living expenses. With no mortgage, all this really cuts out is vacations and a few discretionary spending items (I’m assuming ACA will be around or there will need to be further belt tightening if things really drag out). Sure, I could borrow against my home and/or cut the emergency fund down to 6 months but the stress of possibly getting into financial trouble far outweighs the extra potential gains.
Papa Foxtrot says
I think people over-complicate emergency funds. I have heard everything from a few hundred to 9 months of salaries. I think people just need to find what makes them comfortable. After all if you have a few sources of income and an emergency shows up on one of those sources, you should be ok. However, a few thousand put aside always helps. It’s up to you what the “few” is.
ThomH says
First let me preface, that I’m a spreadsheet crazy guy…so it probably explains my radical way of accounting for things. Years ago, I started building spreadsheets to track everything spending, income, and asset related. On subset spreadsheet has my emergency fund (actually many linked spreadsheets).
One sheet has allocations for every large potential expense item in our house (complete with life expectancy of the item, which back flushes to a monthly allocation amount and current saved balance (think of things like roofs, appliances, plumbing fixtures, floors, HVAC units, mowers, etc.) so this bucket currently has approximately $40k-$65k at any given time, depending on the current lifecycle of the items tracked. A monthly allocation goes into the accrual bucket each month of roughly $420.00 currently. As things age out and/or break, I simply pay for it from the accrual that is already set aside. I call this my personal CAPEX accrual bucket. (Note: I have a number of rental units, so I had the same type of things in my business accounts for CAPEX rental related items, so it was simply an extension to my personal life’s CAPEX items.)
We have a separate accrual bucket, that is more of a traditional emergency fund. It contains six months of normal monthly living expenses. But I thought it important, that I recognized them as very separate items.
I also have other accruals for new autos, auto maintenance, travel, annual bonuses, gifts, taxes, etc.. All of these “separate” accrual buckets of monies reside in a single HYS (high yield savings) account, so I’m at least getting 1.7% on the idle money (as of the last time I checked.)
TB says
You allocate like $5 (for example) a month for a new fridge then? Once the fridge allocation hits a certain amount do you stop allocating for that category?
Steveark says
We’ve got about 6 years worth of expenses in our cash bucket now. But back when we were first married and had a mortgage on a new home we generally had a year of expenses or enough to write a check to pay off the mortgage, whichever was the larger of the two amounts. After only a few years the one year of expenses was a bigger number than paying off the house. Then we paid the house off anyway.
PWilliam says
I am 54 and have become __super conservative__. Up to Covid-19, I kept $750k in cash, CDs and conservative real estate trusts and a little over a million in stock index funds. We carry zero debt on our house or cars, and my wife will have a (now super rare) defined benefit pension that she has been in for near 30 years (present value of about $550k now). With current market turmoil, I realized that I would like to up that conservative part of my portfolio to a million dollars, and I have have done that move during the recent market strength, while drawing my stock portfolio back down to the $750k range. We spend and donate about $5k a month, so a million in conservative investments means roughly 16 years in expenditures. With that bolster in secure assets, I will go back to investing $10k or so a month into the stock market. It is pretty far from the ESI writer who increased stock purchases using margin, but I sleep well at night and have a net worth that is higher than a year ago.
MrFireby2023 says
The majority of American families are heavily indebted and frankly don’t have their shit together, financially. I’m a believer in one year of expenses held in cash, in the form of laddered (or penalty-free CD’s). The reason for one year is because a job loss is a major emergency and depending on one’s age and profession, it could take a long time to replace the job. My good friend is a pilot at Delta. He’s been grounded for 8 weeks and could lose his job. He’s mortgaged to the hilt (High maintenance wife, Private school for his brats, etc.) and has very little savings, only a large 401k which would be costly (tax wise) if he had to tap it.
I recently paid off my mortgage and I still have one year if expenses set aside. Now that my expenses will be so low, I plan to sock away another year’s worth over the next 12 months. Ideally, I’ll semi-retire by late next year, on my 55th birthday. I’ll quit my corporate job, get a part time job at my local gun store/shooting range and enjoy retirement.
Even though I’m down quite a bit this year, stock market as well as crowdfunded real estate investments, invested solely in hotels which will go to ZERO, I’m still in decent shape financially. My tax losses this year will total approx. $450k. Until I paid off my car loan and mortgage this past week, I felt devastated, a failure. Now I feel liberated to be debt free.
I may lose my job later this year if Covid surges once again, which means I’ll be in line at the local food bank but at least they can’t repo my car nor take my home!
Diogenes says
Thanks ESI! Great post, and great timing. Question: For a married couple with middle class careers/salaries and no other sources of income, does it make sense to have a bigger emergency fund as a safety net for emergencies such as loss of job or health problems happening back to back or at the same time? I’m talking 2 to 3 years worth of expenses.
I know some people advice against this saying that a smart investor would keep no more than 3 to 6 month worth of expenses and invest the rest, but I’d like to know your opinion. Thank you!
MI-119 says
No problem if that’s what you’re most comfortable with so long as you are not avoiding tax advantaged opportunities annually in your retirement accounts.
I get the same criticism. I keep a 1 year emergency fund, and another 3 months in an untapped HELOC. People freak out when they hear my annual expenditures approximate $2M.
However, I’ve never not contributed to tax advantage retirement accounts, which are on track to approximate 8 figures upon retirement. I also have other investments in RE and my business, so it’s not like my cash equivalent reserves are a massive drag, only about 12% of NW. If your reserves are too high a percentage of your NW, say over 50%, you may be leaving too much return off the table to have the 2-3 years of reserves. Since both of you work, it’s not impossible but unlikely for both of you to lose your jobs simultaneously, so you have options.
One of my reasons for the cash reserves, waiting for a more attractive risk/reward ratio in the markets so there may be times where larger reserves (late stage bull run, ie treasury inverted 2019) are wiser than other times (new bull, ie. 2009). I feel we’re kind of in a confused middle stage right now in the economy/markets. Dry gunpowder (cash) just feels good right now.
Diogenes says
Thank you, MI-119!
ESI says
I think it’s up to you — whatever makes you feels comfortable.
As you can see from these comments, there’s a wide range of what people feel comfortable with!
Diogenes says
Thank you, ESI!
getagrip says
I guess I’m a little off the norm in these responses as in my working “emergency fund” is pretty small, maybe a month or two of expenses, and has been about that most of my life until the last few years. I kept it this way since I had a pretty stable job and usually carried four to six weeks of “time” over every year, so if I lost the job, I would have that to add to it. I also figured, if it was a real emergency, there goes the college savings for the kids, we’ll deal with college when you graduate high school. So in essence for a true emergency I had a lot I could draw from before dipping into home equity, retirement savings, credit cards, or loans.
That said, my one child living out of state has been out of work since mid March due to COVID 19. While I’m glad my child had about four months saved as an emergency fund, when you lose your job while tons of others have lost a job and the jobs you had depended on retail and travel and now everyone is trying to get any job they can possibly qualify for to include things you did before, it’s really hard to keep on your feet and keep searching for something to keep you going. I’m figuring on a 50/50 chance they won’t get a job before their money runs out and they’ll have to move, likely home or to another relative. I’ve offered to pay for some on line courses that could benefit them (education and health issues are my weakness in helping them out) regardless of where they go but otherwise I’m not willing to fund their living in another state like some of their friend’s parents. We will see what the future holds.
Big-D says
You asked the question about why 3-6 months for an emergency fund. I have read/heard the reason why is that it takes somewhere between 2-4 months to get a new job if you are laid off, plus a month or so to get paid properly (direct deposit, full pay cycle, etc.) once you start a new job. So if you have 3 months emergency cash – then you “only” have 2 months to find a new job before you have to do something more drastic.
For me, I honestly don’t know my budget. I know I am spending less than I earn. I just moved (Indiana to Washington in Feb) and still am working out the particulars (COVID doesn’t help) of my new normal. I can say I shoot for a dollar amount. I try to keep my cash at about $15k. That as 9 months spending when I lived in Indiana. When my account got over $20k, I dumped $5k into the stock market.