Author Topic: Emergency fund, THEN investing? Or both at once?  (Read 3774 times)

Uncephalized

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Emergency fund, THEN investing? Or both at once?
« on: July 17, 2012, 02:45:56 PM »
I'm thinking about whether it is better to build up the cash emergency fund first, because you might need it unexpectedly, or to maybe go half EF/half investments until your EF is as big as you want it, then go 100% investments. The obvious trade-off is that building your emergency fund first gives you more short-term security but lower gains because every dollar-year you don't invest is less lifetime return.

Any thoughts? Is it all down to risk tolerance or is there some math I haven't thought of that might inform the decision? I'm leaning towards the 50/50 split between EF and investments right now; just thinking with my gut though.

EDIT: I am still contributing to my 401k of course regardless of what I do with my take-home pay.

SpendyMcSpend

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Re: Emergency fund, THEN investing? Or both at once?
« Reply #1 on: July 17, 2012, 02:48:05 PM »
I'm thinking about whether it is better to build up the cash emergency fund first, because you might need it unexpectedly, or to maybe go half EF/half investments until your EF is as big as you want it, then go 100% investments. The obvious trade-off is that building your emergency fund first gives you more short-term security but lower gains because every dollar-year you don't invest is less lifetime return.

Any thoughts? Is it all down to risk tolerance or is there some math I haven't thought of that might inform the decision? I'm leaning towards the 50/50 split between EF and investments right now; just thinking with my gut though.

EDIT: I am still contributing to my 401k of course regardless of what I do with my take-home pay.

I think it depends.  If you own a home, you need to set aside some money in case the hot water heater breaks and you don't know how to fix it yourself.  Things like that aren't really emergencies though.  You should have a house repair fund set aside.  Same thing for unexpected loss of income.  Even if you have a HELOC or something like that, if you lose your job, the bank might close your line of credit.  So you do need some emergency money set aside, just nothing too excessive.

ETA:  I'd save 3 months expenses first, then invest, then go back to building it up a tad more for repairs.
« Last Edit: July 17, 2012, 02:53:09 PM by Meadow »

Uncephalized

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Re: Emergency fund, THEN investing? Or both at once?
« Reply #2 on: July 17, 2012, 02:53:13 PM »
I think it depends.  If you own a home, you need to set aside some money in case the hot water heater breaks and you don't know how to fix it yourself.  Things like that aren't really emergencies though.  You should have a house repair fund set aside.  Same thing for unexpected loss of income.  Even if you have a HELOC or something like that, if you lose your job, the bank might close your line of credit.  So you do need some emergency money set aside, just nothing too excessive.
We don't own a house yet, but if all goes according to plan we will within the year. So no equity to leverage or maintenance costs to deal with just yet, though it will become a concern soon and saving separately for that beforehand is probably a good idea.

With a 50%+ savings rate we should be able to save up a 6-month emergency fund in 6 months even with half of our surplus going to investments, so I'm not terribly worried, just interested in perspectives.

DaftShadow

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Re: Emergency fund, THEN investing? Or both at once?
« Reply #3 on: July 17, 2012, 05:04:22 PM »
I've found the best way to make a decision like that is to do the math and compare both alternatives. 

Let's set a Goal = $6k in 6 months.  That's $1k saved per month.  (guesstimated, adjust to fit your numbers if they are much different).  Then estimate a 10% annual return.

In this case if you invested the monthly $1k cash now it would be worth $100 extra in a year.  Since you reach your savings goal in 6 months, so cut that in half (6/12).  Each month after this is worth even less, but we'll do simple assumptions and say that each month you save versus invest, costs you $50.  Multiply by 6 months and that's max $300 over the course of an entire year, and likely much less, closer to $200, if you do the complex math :)

So, your choice is between:
  • extra one-time $200 at the end of a year
  • having a liquid cash-buffer in place to protect yourself.

I leave it in your hands which is more important to you.  Good luck on your journey.  :)

~ DaftShadow

arebelspy

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Re: Emergency fund, THEN investing? Or both at once?
« Reply #4 on: July 17, 2012, 05:17:43 PM »
It really depends on your situation.

Stable job?  Less need for emergency fund.
Lots of cashflow (i.e. high savings rate)?  Less need for emergency fund.
No dependents? Less need for emergency fund.

Someone single, with stable job, saving 70% of their income needs no emergency fund.

Someone self employed or at an employer going through layoffs with two kids and only saving 10-20% of their income needs an emergency fund.

Determine what's right for you.  It won't be the same as what's right for others.

There are also other options, such as contributing to a Roth (and then using the fact that you can withdraw principle any time tax and penalty free).

And it's not always as simple as the math. DaftShadow, for example, fails to take into account the opportunity cost of having an emergency fund versus having that invested and going emergency fund free (although I suppose he is calculating emergency fund now vs later, rather than not at all).

In any case, you need to decide what to do based on your situation, not based on what someone else on the internet decides they want to do.
« Last Edit: July 17, 2012, 05:20:39 PM by arebelspy »
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bogart

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Re: Emergency fund, THEN investing? Or both at once?
« Reply #5 on: July 17, 2012, 09:48:43 PM »

EDIT: I am still contributing to my 401k of course regardless of what I do with my take-home pay.

Personally, I am a fan of dumping the balance of the EF, up to the legal max, into a Roth before each year's annual deadline (so before 4/15 of 2013 to make the contribution for 2012, put in $5K or $6K depending on your age, unless you are married, in which case double those amounts counting a spouse's account, to which you can also contribute -- this would, of course, assume combined finances), and keeping it in cash or cash equivalents if it's doubling as your EF (which in this model you would be).  You can then withdraw that contribution anytime you need to (i.e. if you have an E).

Of course, this is only worth doing if you can distinguish between a true E and a faux E, and if you can't contribute to both a Roth and an E-fund. But I for one, finding myself so situated (able to distinguish between the 2 types of Es but unable (or insufficiently committed as the case may be) to fund both accounts) have been doing this for years.  Obviously you don't need to keep more $$$ in the Roth in cash equivalents than you would want to have on hand in an EF.