The Emergency Fund, Revisited
Walk before you run, kid.
One of the most oft-cited stats I see in the finance sphere is the one about how many Americans can come with $400 in an emergency. The answer: 40%. In other words, almost half of all US citizens. That’s a scary number, to see how many people in our country are so close to financial ruin. One wrong choice or accident can push you right off the edge.
When you’re still relatively young, you don’t want something like that to derail your climb to wealth. Anything that gets in the way of your millionaire dream life should be ruthlessly dealt with and prevented; use your fears smartly against this. And before you recline on the deck of your yacht with the sun dappling prettily off the waves and your oiled-up body, you need to deal with emergencies. Specifically, the possibility of emergencies. You don’t want a sudden setback to knock you off the wagon this early!
You know at least one person who this applies to: “I was living paycheck-to-paycheck and then the engine in my car stalled out, which cost thousands of dollars to replace. I didn’t have the money to deal with that. Because I couldn’t drive I lost my job and got behind on even more bills. I got into so much debt because of this.”
Don’t let that be you. This person is nowhere near that yacht when they’re worrying about how they’ll pay for groceries or keep their housing. With an emergency fund this is mitigated. This emergency fund keeps you worry-free even if the market takes a dump, you lose your job, and get a hefty speeding ticket at the same time. That fund keeps your head afloat during any unexpected tribulation, at least for long enough to regain your bearings.
How to Start Your Emergency Fund
I’ve heard emergency funds referred to as “training wheels,” which is a great metaphor. Without an efficient teacher who can get you going in a day, you need some basic oomph to get you pedaling to where you want to go.
Firstly, your emergency fund needs to be in a checking or savings account. No CDs, bonds, index funds, gold bars, or anime memorabilia. Your emergency fund needs to be liquid, which means you can get to it ASAP without jumping through hoops to do so.
If you’re starting from scratch, set two goals to reach. Goal #1 is saving $1,000. Once you reach that, Goal #2 is reaching about 3 months worth of expenses. If you spend $2,000 each month, for example, aim for $6,000. If, for any reason, you’re suddenly unable to work or bring in enough income, this amount will cover you for the next 90 days. 90 days is ample time to get your affairs back in order and running smoothly.
Once you reach the 3-month amount, decide whether you think that’s enough or not. You might decide to put some more money in your emergency fund for peace of mind. There’s several good reasons to do so, including if you have unstable income or have dependents. This is up to you and your comfort levels.
Besides this emergency fund I also have some cash on hand for a “we’re sheltering a Marvel superhero, run for the hills” type of scenario. It’s not more than $1,000 and it’s not less than $200. This is for my own comfort; while it loses money to inflation every year, I value that comfort more highly than the potential investment gains. This is YOUR money after all. Make sure you feel comfortable with it!
Your Pro Emergency Fund, Revisited
I have noticed there’s several finance-savvy folks that read these posts. If you’re one of them, you’re likely rolling your eyes at this standard advice. “Duh Darcy, I already have an emergency fund and it’s definitely more impressive than yours. What new information can you give me?”
Let’s find out! Congratulations on building your emergency fund, and for your continued success. Once you’re in the mindset of success, and with the financial health to prove it, you should go back and revisit the amount in your emergency fund. Generally I’d only recommend this if you have at least six figures of net assets, as this proves you know your way around finance and less likely to go bankrupt.
In my case, I had dutifully created my emergency fund as my first step to success. As time went on and my assets kept rising, I looked back at my $7,000 amount and not feeling happy about the number. My income was stable, my company wasn’t shady, and I had reliable cash flow during a bull market run. Why not take some of that cash and invest it instead?
So I looked into it.
Running the numbers made this make sense. One monthly credit line alone is more than $5,000. Since I don’t use credit to pay my rent I end up using <$500 of it month over month, leaving thousands that can cover me in an emergency. And since I can trust myself to use credit cards responsibly, I knew I wouldn’t be tempting fate if I used a card as an additional emergency buffer.
If I do have an emergency, I’ll have three sources of cash to throw at it: my emergency fund revisited, my credit line, and my monthly cash flow. This is only possible because I have a history of responsible saving and credit habits. If you’re a beginner and considering going this advanced too quickly, you’re only shooting yourself in the foot.
What are your thoughts on an emergency fund revisited?
I remember seven years after college already having enough in my emergency fund to pay off my house mortgage, which was the only debt we had. We didn’t pay it off then but to me that was the least in liquid reserves I could be comfortable with. That was probably $120,000 in today’s money but much less back then. Sure we missed out on some compounding but at the aggressive rate we kept saving and investing it didn’t matter that much. Now we have over ten years of expenses in our cash bucket and far more in bonds and the most in index funds. I don’t see a problem with your strategy, it’s got great math support, I just wasn’t that bold. But being bold when the math supports it is smart. Good post.
Thanks Steve! Always enjoy seeing your comments and input 🙂 You’re right on doing what you felt was best – that’s the whole point of finance in the first place, to make you as secure and happy as possible!
i’m all for liquidity and that is available cash. we keep cash on hand at home too, like the green money kind. it’s not excessive but we have it in case of emergency and maybe the power and/or atm’s aren’t working. you never know. also, sometimes it’s nice if you’re headed out for some social time to use it as an atm and replace later in the week. it has come in handy.
i agree with step one being an emergency fund. for us it’s a combination of e-fund and sinking funds for taxes, vacation, overtime, and roth contributions. with those other categories in the same account it makes the fund at least double what the e-fund part is. it’s the first thing i did when i got this decent job 15 years ago and have never regretted it.
Exactly, who knows what life will bring you? Even if all you use it for is during those social outings, it’s better to have it on hand than not. And no downsides to boot!