Need Advice- Invest in 401K or Build Emergency Fund?

[mustachiogirl]

I need some advice please. I have a new job, and with it I have an opportunity to invest in the company 401K plan. I am 40 yrs old, and have zero retirement savings and zero emergency funds. Now, I know that my first priority needs to be building an emergency fund. But how much? Should I also be investing in the 401K plan simultaneously? My co. offers 75% match up to 6%. So if 6% of my income was an imaginary $100, then they would give me $75 just for investing that- SWEET!

If I don't sign up for the plan now, I will have to wait a full year before I can enroll again. Should I at least put in the 6% so that I get the "free" money? Or, should I put 100% of my excess income toward building an emergency savings first, then go back and enroll in the plan next year? Thoughts??

[ThatsMyOtter]

You'll need to provide some more details, but I would recommend contributing the 6% to get the match IF you're able to meet your basic expenses while doing so.

How much is the new salary compared to your previous one? What percent of your new salary goes to basic expenses? What does your current budget look like--super mustachian? Exploding volcano of wastefulness? Actual numbers would be helpful. Any debt? If so, what kinds?

I hope you like your new job!

[Another Reader]

The fact that you are 40 and you would have to wait a year if you did not sign up now would push me to sign up for at least the 6 percent to get the 4.5 percent match.  I would ratchet down the spending and start to build an emergency fund from the first paycheck forward as well.  Of course, debt and living expenses are part of the decision, but I would set up some trial budgets that included the 6 percent to see if I could make it work.

[matchewed]

For an E-Fund it all depends on your risk tolerance. This is determining how secure your job is, do you have dependents, can you cut your expenses if you lost your job, do you have other sources of income...etc.

I would invest in your 401k to get the full match. Your companies match would look more like this - if you made 100 and contributed 10% they will match .75 to every dollar. In this case you contributed 10, your company would have provided .75 to every dollar until they hit 6.

In a more realistic scenario say you make 50k. You contribute 10% (5k) your company by the end of the year would match .75 for every dollar you put in up to 3k (.06*50000).

So the best method to maximize your match while minimizing the amount contributed to the 401k would be to take your gross salary and multiply it by .06. Then divide that by .75. This gives you the number you should try for for your contribution annually. Divide that by your gross salary and that gives you your contribution percentage.

[Numbers Man]

I would do both. Invest in the 401k plan and build up the emergency fund.

[mustachiogirl]

I do have other sources of income... a home biz and child support. I have pared down my budget so that I am living on about 30% of my total income. But this is all very new to me (having excess income) and I am not sure where to start when it comes to saving. I know we need to have emergency cash, but how much? Is it cost of expenses multiplied by a certain number of months... if so... how many? And once I reach that amount, should I then go back and work toward maxing out my 401K? Or is there a step in-between that I am not aware of?

[mistershankly]

I do have other sources of income... a home biz and child support. I have pared down my budget so that I am living on about 30% of my total income. But this is all very new to me (having excess income) and I am not sure where to start when it comes to saving. I know we need to have emergency cash, but how much? Is it cost of expenses multiplied by a certain number of months... if so... how many? And once I reach that amount, should I then go back and work toward maxing out my 401K? Or is there a step in-between that I am not aware of?

You can take a couple of approaches towards building an emergency fund... 1) save 3-6 months' worth of base expenses (rent/mortgage, utilities, food, gas).  This will cover you should you briefly lose your income source and need time to change gears and make adjustments to another job or other living situation.  2) If you feel confident in you income sources staying steady, save the amount of money in your emergency fund up to what your immediate cash needs would be to pay your insurance deductibles if everything happened in a short amount of time (ie. medical emergency, car accident, etc).  For example, if you carry a $1000 car insurance deductible, $5000 home deductible, and $1000 health insurance deductible, an emergency fund would need to be $7000 (maybe $8000 to cover minor car repairs, etc).  If you choose #1, you can always sell some of your invested funds to get the money you need (if it exceeds your saved amount) but if you prefer to leave it untouched and self-insure, then #2 may be the best way to go. 

Personally, I've changed from #1 to #2 as I was able to save enough to cover higher deductibles (thereby lowering monthly premiums and allowing more money to be invested and grown) while growing a larger investment portfolio.  Over time, I felt like the money saved in excess of the deductibles could be better served in an index fund and growing, and I was more willing to risk it in a more aggressive investment than a savings account.

Either way, I feel you should do what is most feasbile to you at the moment (financialy) considering your potential financial obligations in the big picture and your risk tolerance.  Others on this board may have some differing opinion on this strategy and I certainly would love to hear their perspectives as being open to change and embrace new strategies will only lead to a stonger foundation and success.

As far as the 401k goes, I would take advantage of getting into it now while working up that emergency fund.

[mustachiogirl]

Thank you MrShankly... good advice. I had taken the Dave Ramsey Financial Peace course and he recommends not putting anything at all into the 401K until I have an emergency fund built up... but that seems like just saying no to free money (equivalent to a several thousand dollars over a one year period. I am thinking that I should probably at least do the 6% to get the highest match possible. That will give me a year to build up my emergency savings and the I can raise the amount I contribute the following year.