Emergency Fund?

[kudy]

I have heard from many financial planning folks that a cash emergency fund is an important thing to establish first and foremost - I've been putting away a pittance towards an 8 month emergency fund for quite a while, but I recently started a new job with a higher salary, and I will be able to actually save 8 months worth of expenses in a year or so.

Despite my plan to save an 8 month fund, I am constantly second-guessing myself - do I need 8 months worth? does it have to be cash (earning ~1% interest)? should I pay down my mortgage instead? aren't there other viable options for emergencies other than a big pile of money that isn't working for me?

So I guess my question for all of you is, how do you approach the traditional idea of an "emergency fund"?

[arebelspy]

It depends on a number of things such as your risk tolerance level and job stability.

The wife and I are teachers, and it's basically impossible for us to get fired.  (I wish it were easier for them to fire teachers though.)

So we don't keep a huge "emergency fund."  If I was at a company that was in trouble, if I just missed a round of downsizing, or whatever, I'd definitely keep more available.

MMM has posted about having a spongeable emergency fund, here: http://www.mrmoneymustache.com/2012/02/22/reader-case-study-getting-blood-from-a-stone/ (I am not the teacher in that article.)

He unequivocally states, in the comments: "Mr. Money Mustache is not backing down on this one. BIG EMERGENCY FUNDS ARE DUMB!!"

That's a direct quote.  And a great example of why I love MMM over every other PF site.  He states it how it is, and doesn't hedge. "Er..um.. in some cases.. well.. you see.."  He says it, and is right.

Do you actually need the emergency fund, because a potential emergency is on the horizon?  Can you have a spongeable one via HELOC or something similar?

[kudy]

I would love the option to use a HELOC, but I have no equity (another reason why I am so anxious to start paying down my mortgage).  I can't think of anything besides a large amount of available revolving credit that I could consider a backup option.

Thank you for pointing me at the MMM article, I always like to hear what MMM thinks about a topic.  As mentioned, I recently started a new job - it's a very promising start-up situation, and we have funding for a number of years, but I keep in mind that there's no guarantee I will be kept on after a year or two if things aren't going as planned.

I think my potential for finding other employment should I lose my job is great, but again, I tend to lean towards the cautious, and don't want to bank on my confidence.

I have a house maintenance fund already, so in the case of any larger home maintenance costs, or emergencies I can cover the cost/deductible.

[sol]

If you have a Roth IRA, consider that contributions are quickly available without penalty or taxes, just like a savings account.  I recommend that you consider your Roth IRA balance as part of your emergency fund, as long as you consider it for actual emergencies (tornado eats your house, bail bond, cancer) and not for quasi-emergencies (found a sweet deal on a new car, house needs a new roof).

[kudy]

I can pull my contributions out of a roth IRA tax and penalty free, but not the earnings in the account, correct?

In this case, I guess I am only really considering unemployment or disability/long term sickness as an emergency - for everything home related I have insurance and a home savings account.

[sol]

I can pull my contributions out of a roth IRA tax and penalty free, but not the earnings in the account, correct?

Correct.

In this case, I guess I am only really considering unemployment or disability/long term sickness as an emergency - for everything home related I have insurance and a home savings account.

Fortunately, both unemployment and disability are already separately insured by our social safety net.  You're golden.

[Bakari]

I keep only $1000 in cash.
Aside from my IRA, I have enough in various investments to live on for a year (with only slightly more frugality than usual)
Worse case scenario, I lose capital by having to withdraw when markets are low, but since that would only be for emergencies, I'm not really worried about it.

[onehappypanda]

I like having enough liquid cash to hold me over in case something happens that I'd want cash quickly for- paperwork gets messed up and my monthly paycheck comes late (relevant to me because all my bills are due within a week of my monthly paycheck), I have to travel for an emergency, cat gets sick, whatever. Not necessarily enough to live on but enough to hold me over. That amount varies from person to person I'm sure, based on their expenses and their situation. I currently have a $1K emergency fund and I'm looking at $2K.

I agree with the others that you might want to consider whether any of your investments are easy to withdraw from (without huge penalties or a hassle) and factor that in as part of your savings. But I do think there's some benefit to having cash in a savings account, just not necessarily a huge amount of it.

[Lars]

I see an emergency fund as essential if you live paycheck to paycheck or are just starting the FI/MM journey but less important the more progress you make and the higher your savings rate. Well before you're half of the way there and maybe even before you're a quarter of the way there, you will have enough assets to take a line of credit against or to serve a backup function as an emergency fund. As a rule of thumb, I think the more difficult it is to build an emergency fund the more important it is.
As for the exact amount, I prefer to get it through analysis. I consider the most probable emergencies - disability, job loss with extended search, death in immediate family, very expensive (before insurance) medical emergency,  etc. and estimate what it would cost me if it happened and pick the biggest number for my emergency fund or at least 3 months of current expenses. (Note don't forget things like insurance, moving in with family, selling the house, etc.) Alternatively you can pick the number of a favorite expert - If I was your favorite expert your number would be 6 months. :)
 

[kudy]

Lars, that's an interesting point that seems pretty valid to me - I am not in debt, but I would definitely fit into the category of just starting my journey.

[velocistar237]

I agree with the others that you might want to consider whether any of your investments are easy to withdraw from (without huge penalties or a hassle) and factor that in as part of your savings.

This is similar to what I read in this post:
http://badmoneyadvice.com/2009/10/conventional-wisdom-the-emergency-fund.html

The author talks about a checkbook linked to his brokerage account. As others have said, an emergency fund makes sense if you're starting out, and much less so later when you have other equity to draw against cheaply.

[arebelspy]

I see an emergency fund as essential if you live paycheck to paycheck or are just starting the FI/MM journey but less important the more progress you make and the higher your savings rate.

This is a brilliant point. Everyone focuses on assets you can liquidate, but your savings rate is super important, especially if you have a stable job.

So basically as long as your emergency isn't losing your job, you can weather it simply from your paycheck and not saving that month.

For example, the wife and I have about a 70% savings rate.  We put away maybe 5k/mo.  If we had an "emergency" that cost us 5K (say, major car repairs), we wouldn't have to have any cash available or liquidate anything.  We'd just put it on a credit card and pay it off at the end of the month (paying no interest) from our normal paychecks.  We just wouldn't be able to save that month.  Emergency fund required to deal with that 5K emergency?  $0.

If you are only saving $100-200/month (say, what a non-Mustachian might be doing), it's a LOT harder to weather a 5K emergency.  Your savings rate and amount you save monthly can easily affect what your emergency fund "should" be.

[Mr Mark]

Once you have a big stash, there is a place for cash in classical asset allocation. (I know right now, it gets 1% [-2% RT] or so)

Plus, we have variable expenses over a year. Having a 5% of annual expenditure cash 'capacitor' away from credit cards is OK IMHO. It's worth it just to ease any hassle

[nolajo]

It's been a while since I've been over to The Simple Dollar, but if I recall, Trent had a good recommendation for an emergency fund. His guidelines were two months of expenses as a baseline plus one month for anybody you claim as a dependent. For example, his family of 5 would require 6 months of expenses (2 months plus 4 months - one for everyone else). I think it makes a lot of sense from the perspective that a singleton or a couple has much more flexibility with some of the drastic measures you might need to take in the case of a long un/underemployment, particularly moving or selling assets.

Naturally, as you get closer to a Mustachian existence, you could do things like keep a HELOC in reserve, sell some stocks, etc, etc. If you're closer to my position though (renter, minimal assets that could be sold, still a technically negative net worth) it seems prudent to make sure you actually have access to some cash. I simply wouldn't want to bank on being able to get a personal line of credit if I was suddenly unemployed - I wouldn't make that loan and I'd be a little surprised if my credit union did.

[AJ]

His guidelines were two months of expenses as a baseline plus one month for anybody you claim as a dependent. For example, his family of 5 would require 6 months of expenses (2 months plus 4 months - one for everyone else). I think it makes a lot of sense from the perspective that a singleton or a couple has much more flexibility with some of the drastic measures you might need to take in the case of a long un/underemployment, particularly moving or selling assets.

This never made sense to me. Yes, parents with kids are going to be more conservative with their emergency funds, but why does it matter if you have 1 kid or 20? They are going to be equally traumatized by poverty. Of course, your monthly expenses will be higher with more kids, but that doesn't mean you need more months. Its a novel approach, to be sure, but it doesn't seem particularly logical to me.

I simply wouldn't want to bank on being able to get a personal line of credit if I was suddenly unemployed - I wouldn't make that loan and I'd be a little surprised if my credit union did.

You are correct that you should not bank on getting a loan *after* you become unemployed. No bank on earth would approve that. The point is to get the LOC now while you are employed so that you can have it available when you are not. But, of course, some people will just be more comfortable with a cash e-fund. Whatever helps you sleep at night.

[nolajo]

True statement, AJ, about the 1 kid versus 20 thing. If you're those people on tv that have 19 or something, you can disregard that. It's long before you hit the double digits that you could revise that plan. I do, however, think that those guidelines makes some sense in terms of flexibility. As a single person, if I find myself unemployed for a while, I have more options than I might be comfortable with if I had kids. I can move into a shared living situation more easily, pick up and move across the country more easily, even crash on a sofa for a while if push came to shove.* 

Believe me, my family went through a period of extended under/unemployment while I was a kid and I know it'll suck regardless, but being able, for instance, to keep your kid in the same school til the holidays can go a long way towards keeping their life from being utterly miserable. In our case, the extra funds meant that when one parent got a job on the opposite coast from where we were, we could finance two (small, shared with family) households for the short term so that my sister and I weren't uprooted in the middle of the year (again) for a contract job that might not renew. A single person could've taken the mid-term contract with the big move to get back into employment without consideration for the family. You don't have to consider it, and it's certainly better to uproot the kids than have the family out on the street because you wouldn't, but a proportionally larger emergency fund for a family can prevent a bad situation from becoming dire.

So that's my overly long explanation for what I may do in a nebulous future where I have kids based on one blogger I don't read much anymore and fuzzy memories from my own childhood :).

I'll be the first to admit that I don't understand LOCs. I thankfully have not had to get one, but I was under the impression that you didn't just take one out and sit on it. Do you? Is it something that you can just call them and say 'on the basis of my current situation, will you guarantee that I'll have funds available if I'm suddenly hit by an emergency at some time in the future?" If that's the case, then I probably will look into it - I presumed the rules were different when you couldn't offer much in the way of collateral. 

*For that matter, even pets can complicate things and might warrant some consideration. It doesn't matter how much I love you and would like to offer you a place in hard times, if you've got a cat, it can't stay here.

[foodguy]

Emergency funds are like personal insurance against anything.  Should the water heater break, you are "insured."  If you lose your job, you are "insured."  (for a while at least).  The cost of this insurance is the opportunity to make more money elsewhere.

Everyone seems so itchy to find better returns by "investing" that emergency fund, but others are comfortable having it sit and earn 1%.

While 8 months is a nice concrete number to hit, the "real" number should be whatever makes you sleep comfortably at night.  For some people that is a HELOC, and others it's $100k in a savings account.

[AJ]

I'll be the first to admit that I don't understand LOCs. I thankfully have not had to get one, but I was under the impression that you didn't just take one out and sit on it. Do you? Is it something that you can just call them and say 'on the basis of my current situation, will you guarantee that I'll have funds available if I'm suddenly hit by an emergency at some time in the future?" If that's the case, then I probably will look into it - I presumed the rules were different when you couldn't offer much in the way of collateral. 

Yep, that's exactly what you do, although I wouldn't phrase it that way :) Find a bank that offers personal lines of credit, apply for one, then let it sit there until you need it. I guess make sure there are no inactivity fees, but I've never seen one that had any. If you've got decent income and credit and need somewhere to start, I have mine with Pentagon Federal CU and another with First Tech CU. Obviously, rates are higher for unsecured that for a secured loan, but I don't pay interest until I use it, so its just free back up.