Author Topic: Do I need an emergency fund and if so how much and where should I store it?  (Read 605 times)

cascademountainman

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Hi, 21-year-old college student here. I just got a fairly significant monetary gift and was wondering what I should do with it? Sidenote: if someone wants to explain why paying down your mortgage vs. putting that money in an investment account is the way to go. My theory is that 4%ish APR is still less than 7% averaged market returns so, therefore, you are forgoing 3% interest so there must be another factor at work here.

Radagast

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See for order to follow: https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153

and the thread below for where if you hypothetically decide to have an EF:
https://forum.mrmoneymustache.com/ask-a-mustachian/which-high-yield-saving-accounts-are-the-best/

My theory is that 4%ish APR is still less than 7% averaged market returns so, therefore, you are forgoing 3% interest so there must be another factor at work here.
Your theory is right. Until you are about to retire (at least halfway), there are no other factors. Some people say the mortgage payment is safer in a lawsuit in some places, but lets face it, if you haven't saved enough money to cover the lawyer fees you are just as safe :).
https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

cascademountainman

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Thanks for the quick reply and for all the information!

reeshau

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My theory is that 4%ish APR is still less than 7% averaged market returns so, therefore, you are forgoing 3% interest so there must be another factor at work here.
Your theory is right. Until you are about to retire (at least halfway), there are no other factors. Some people say the mortgage payment is safer in a lawsuit in some places, but lets face it, if you haven't saved enough money to cover the lawyer fees you are just as safe :).
https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

The other risk factor for a mortgage payoff is your job security and relative expenses.  If you lost your job and it took a significant time to find a new one, your mortgage (as your likely largest expense) may be at risk.  In general, that "just" risks your house, but that would be a significant trauma to many people.  Of course, just because your house is paid off, doesn't mean other financial stresses in the same situation could cause you to lose it: to need to sell at a depressed price to fund your medical costs / tax assessment / etc.

Once the mortgage is paid off, it can lower your mandatory expenses to a level that a lot of people calm down.

From an investing perspective, it's a type of leverage, so it's no surprise that it is higher risk with higher reward to keep the debt and invest in equity instead.

tralfamadorian

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My theory is that 4%ish APR is still less than 7% averaged market returns so, therefore, you are forgoing 3% interest so there must be another factor at work here.

Just a clarification- 7% returns is real (inflation adjusted). Nominal returns average is ~9.7%. If you’re comparing to mortgages, which are stated non-inflation adjusted, then you should use nominal. So, the contrast is even more stark- 9.7% vs ~4%.

Feel free to stop by the DPYM thread here to find a group who does not subscribe to low fixed rate mortgage pay down.

cascademountainman

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Thanks for catching me on comparing nominal and inflation-adjusted rates. Oversight on my part as an economics major. I do not yet own a house so I'm just trying to get ahead of the eightball and my primary current goals are getting through school debt free and building my rainy day fund. If anyone could help with do I really need an emergency fund during college? If I don't need it I can start building up a Roth IRA.

tralfamadorian

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If anyone could help with do I really need an emergency fund during college? If I don't need it I can start building up a Roth IRA.

Your call. A credit card is a perfectly acceptable substitute for a savings account emergency fund but it's a good exercise of avoiding the habit that many have of reaching for a credit card in times of financial stress. I don't know what your income is or what your expenses are but even a modest savings account ($500) is a good idea IMO.

Unsolicited advice- Set for Life by Scott Trench (written by a biggerpockets employee so real estate bias) is a wonderful book about getting started on the right financial foot after graduating college. Inspiring and full of useful, actionable information.

cascademountainman

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 Thanks, I will hunt down that book in the library. Currently, I have about 2.5k in savings so it sounds like it may be time to start a Roth. I am also about to begin my summer job which should only increase savings.