Emergency Fund ideas

[Enphuego]

So after reading http://www.mrmoneymustache.com/2012/02/22/reader-case-study-getting-blood-from-a-stone/ I began to think about my emergency fund or lack thereof.  My wife and I just closed out our credit card debt from a wedding earlier this year and we are now directing our focus towards building an emergency fund.  I've got a student loan I'm itching to pay but I think now is the time to build up some liquidity.  I'm working a government job so getting let go is highly unlikely but I'm fairly new so it's not impossible.

So as I thought about it, I decided that I needed liquidity rather than an emergency fund exactly.  So I took stock of what I had available and thought about what sorts of emergencies might befall me.  So here's the gist of our financial situation, maybe some brainstorming could come up with a better plan than mine.

Income:
 $5,400 /mo
Wife just got her employment authorization so searching for a job soon

Expenses:
Mortgage/Taxes/Insurance - $2,200 /mo
Other expenses - $1,800 /mo
Savings - $1,400 /mo (bi-monthly move of $700 to ING)

Resources:
Available credit - $6,000
USAA checking - $4,000 (where we pay our bills from)
USAA savings - $1,000
ING savings - $700
457 plan - $4,300 (30% bonds, 70% stock) able to take a loan from it
Unemployment - I'd get $1,800 a month if I became unemployed.

Debts:
$2,100 student loan @ 6.8%
$5,400 student loan @ 2.36%
$1,800 credit card @ 0% for over a year

Talking to the wife, she thinks we could get by on $3K /mo if we absolutely had to.  I was thinking of opening a taxable Vanguard account, building up $6,000 in an ETF like VCSH - Corporate Short Term Bonds, then ramping up the 457 until it has $6,000 available for a loan.  I'd probably also keep $2K in savings at ING.  Then I'd have $20K worth of liquidity, or 6 months worth of expenses available from 3 different sources.

Any thoughts?  Am I over complicating this and should I just keep cash in an ING account?  Should I put that $6,000 emergency fund in a Roth IRA instead?

[arebelspy]

Should I put that $6,000 emergency fund in a Roth IRA instead?

Quite possibly.  It depends on how frequently "emergencies" happen to you.  For some people, they seem to happen all the time.  Everything is an emergency to them.  For others, they're quite rare, nothing seems to be an emergency.

You can access the principal of a Roth penalty free.  It'd likely take a few days to tap.  Do you think if something happened you'd need 5K cash that day, or would it be okay getting a check after a few days to pay for that emergency?

For some, it being harder to access is even a good thing, so it won't be wasted on an "emergency" like my friend just invited me to accompany her on an expensive vacation I hadn't planned for and I really want to go.

[Enphuego]

Well we haven't had an emergency in 6 months.  The $1000 I put into that USAA savings account has just been sitting there untouched.

I don't think I'd ever need 5K cash that day.  I can't even imagine the scenario where I would.  Medical emergencies are handled by health insurance, if the car got wrecked we could live without for a while and if I lost my job I'd have plenty of time to move money around.  If I really really needed 5K that day and couldn't put it on a credit card I could always overdraft my checking which puts it on my credit card or do a cash advance.

[arebelspy]

Well we haven't had an emergency in 6 months.  The $1000 I put into that USAA savings account has just been sitting there untouched.

I don't think I'd ever need 5K cash that day.  I can't even imagine the scenario where I would.  Medical emergencies are handled by health insurance, if the car got wrecked we could live without for a while and if I lost my job I'd have plenty of time to move money around.  If I really really needed 5K that day and couldn't put it on a credit card I could always overdraft my checking which puts it on my credit card or do a cash advance.

So there you go.   Sounds to me like you should take that 6k emergency fund, contribute 5k to the Roth (max it for the year), keep 1k liquid, and if an emergency happens that you absolutely need it, you can access it after a few days.  In an emergency, you can charge on a credit card and then pay it off before paying any interest by tapping the Roth.  Ditto job loss, or whatever.  No need to keep 6k in cash, IMO.

Since your job sounds stable, that seems like a reasonable course of action.

After that, you can work on paying down the student loans, if that's what makes you happy, knowing you have that cushion in your Roth if necessary.

[James]

Debts:
$2,100 student loan @ 6.8%
$5,400 student loan @ 2.36%
$1,800 credit card @ 0% for over a year

I would pay the 6.8% student loan first, you can have the paid off with three months of your savings.  It's one less item on your list, and the rate is high enough to make it worth paying off quickly.  Second I'd pay off the credit card just to get that off the table.  You might have until the end of the year, but if an emergency comes up and you can't pay that off by the end of the year the rate will probably shoot sky high.  Heck, I'd pay off all the debt before saving more than the buffer you have in checking, but that's just my preference.  I don't like non collateral debt.  But financially there is an incentive to just make minimum payments on those two and invest in something that should give back higher interest over time.  In either case the Roth is probably your best bet for your savings, at least until that is maxed.

[Will]

Don't mean to hijack this thread, but this seems like a good place to bring it up (instead of starting a whole new thread):

I recently read http://www.mint.com/blog/saving/does-using-a-roth-ira-as-an-emergency-fund-a-good-idea-052012/ and it seems like a good idea to me.  I was wondering what asset class would you use, if you already have a mixture of traditional IRAs with Vanguard's Total Stock Market, some large and small blends, international, and a TIPS fund?  More bonds?  Something balanced, like Vanguard Wellington?  My only Roth right now is T. Rowe Price Spectrum Growth.

Like the OP, I haven't really had any "emergencies" and wouldn't need cash the same day.

Thanks in advance, and if this wasn't the proper place to put this, let me know and I'll start a new thread or whatever.

[grantmeaname]

If it were me, I'd look at it in aggregate with your entire stash when you're figuring out what to hold in it. If you're heavy on stocks, that would be more bonds, but if you're reasonably balanced right now it could be just stocks, for example.

Some of the forum posters are a bit more conservative than me. If you believe that you are most likely to have an emergency when the market is down, it may make sense not to keep your emergency fund in stocks and bonds because you'd then have to cash out when you would want to be buying. For most emergencies, I don't think they're that highly correlated, though... your broken ankle and your sump pump don't care if the Dow is down.

[trammatic]

I agree with the aggressive emergency fund...it doesn't make sense to have that moeny sitting around doing nothing for you, especially since most non-employment related emergencies can be fixed for under 5 grand.  As long as you're in the "my debt is an emergency" camp, why not use a line of credit to fund emergencies.

OP has access to 2400/month for emergencies (5400 pay, and can live off of 3000).  If you have a 5k emergency and charge it to a 15% APR card, you'd be able to pay 2400 interest free when the first bill came in over a month.  Get charged roughly 32.50 in interest for the 2600 balance for that month.  Pay 2400 of the 2632.50 the second month, get charged 7.91 in interest for the second month, and pay the entire 640 in the third month.  Thus, you'd pay somewhere about $40 in interest for an emergency.  Say you have one emergency every year.  Then your investments on 5000 would have to net more than $40 of 0.8% to make it worthwhile to invest the 5k instead of keeping it liquid for an emergency.

Obviously, this calculation depends on a savings rate as well as the rate of debt.  If you have home equity, then a HELOC seems perfect.  You can get a 3.5% rate now, plus interest paid is tax deductible, so the opportunity cost of carrying cash is really high.

[skyrefuge]

In an emergency, you can charge on a credit card and then pay it off before paying any interest by tapping the Roth.

But it's not clear to me that it would make sense to even tap the Roth in that case.  Going by trammatic's math, a $5k emergency will cost something like $40 if charged to a credit card.  I'm not sure about all the math, but it seems like pulling the money out of a Roth could "cost" a lot more than $40, because once that money is pulled out, you can't stuff it back in (unless you get it back in within the 60-day rollover window, which seems unlikely in the case of a real emergency).  And that means you lose out on a boatload of tax-free earnings.  $5k earning 5% tax-free for 30 years results in $16.6k of interest, while it produces only $12.4k if the 5% is all dividend income taxed at 15% every year.  The tax consequences probably won't be that bad in reality (if held in a taxable account it wouldn't make sense to keep it in something that produces 100% of its return in dividends), and on top of that $4.2k in 30 years is worth less than $4.2k now, but it's difficult for me to imagine those factors being derated to the point where the hit you take from pulling out that $5k is less than the $40 in credit card interest paid today.

Of course this is only really an issue if the investor is maxing out all his tax-advantaged contributions every year, and is "forced" to store his additional "overflowing" savings in a taxable account.  That may not apply to the OP, but it's not a totally unusual situation among Mustachians; it certainly applies to me.  I'm mad enough that I missed out on the chance to stuff money into a Roth for a couple years early in my career, and I'd be even more mad if I consciously yanked existing money out of that nice cozy shelter.