My Thoughts On An Emergency Fund

An emergency fund can be a vital part of your overall economic and personal finance plan. While I don’t believe in having a large part of your net worth in cash that sits in a bank account, an unforeseen accident or emergency can produce an immediate need for instantaneous cash. During times of distress cash is King. An emergency fund is basically cash set aside to pay for emergency expenses.

Accumulation Mode

I’m currently in “accumulation mode”. What I mean by that is that I’m currently accumulating assets that will pay me to own them. These assets will fund my early retirement. Because of that, cash really does me little good. Cash in large amounts while I’m trying to accumulate equities provides an opportunity more than anything else. At this current time I think of having large amounts of cash as an opportunity to pounce on stocks when the market prices them at discounts to their intrinsic value. During these times of extremely low interest rates, having lots of money in the bank is counterproductive, as inflation will erode your purchasing power over time. Cash is historically a horrible investment vehicle.

At this time, because I am in accumulation mode, I like to keep 3-4 months worth of expenses in cash. It does fluctuate a bit, as I will drain the emergency fund a bit when the market is down and hold on to slightly larger amounts of cash when the market is up. I like to think of emergency funds in terms of percentages of your expenses, instead of absolute dollar amounts. Because my expenses are fairly low, having $4,000 or so in cash readily available usually suffices for me. Cash is just one part of my emergency fund, however. I also currently have $5,000 in a revolving credit line available to me should a large emergency ever present itself. There are few things these days you can’t purchase with a credit card, so this is my ultimate backstop. Of course, I could also sell equities if something truly catastrophic were to happen to me.

An Emergency Fund Should Be Tailored

While I feel the numbers I’m presenting to you today work for me, I think an emergency fund is something that should be uniquely tailored to one’s own situation. Some questions that are pertinent include:

* Do you have children?

* Do you own your own home?

* What kind of insurances do you have?

* Do you have elderly family members that you may be responsible for?

* What are your monthly expenses?

* What kind of cash flow do you have?

* Do you have a large number of liabilities? Are you drowning in debt?

* How secure is your employment?

Be Honest With Yourself

These kinds of questions will give you a strong idea as to what kind of emergency fund is appropriate for you. I don’t have any children, my family is young, I have fairly low monthly expenses and I rent. I think if you own your own home you should definitely have extra money set aside for household repairs and improvements. I rent, so anything that breaks is the responsibility of my landlord to fix. I have pretty strong cash flow as I currently save well over 50% of my net income. A small emergency could be taken care of by the large buffer I have between income and expenses.

One of the questions I posed deals with debt. If you have large amounts of personal debt like credit cards and car payments (and even a mortgage), your first priority should be reducing and ultimately eliminating that debt. If you have a large amount of money in the bank earning .024% while you’re paying 15% on your credit card balance you’re doing yourself a disservice. I don’t believe in having $0 in the bank, but you should minimize debt at all costs. I currently only have student loan debt. The interest rate is below 3% and it’s tax deductible. I’m in no hurry to pay this off at this time.

My personal risks involve insurance. I currently don’t own a car or a home, so I carry no insurance for those types of items. However, I currently carry no health insurance. I’ve been extremely lucky as I’ve had no major medical issues since hitting adulthood. I’ll likely be changing this soon as I approach 30 years old.

Once You Retire 

Once I hit my ultimate goal of personal financial freedom by 40 years old, I’ll be saying goodbye to the 9-5 (7:30-6 in my case) and saying hello to sleeping in, traveling and spending more time with loved ones. Once I become financially independent and decide to part ways with full-time employment, my buffer between income and expenses will likely be gone. While I still plan on my passive income to exceed my expenses, the buffer of ~70% I currently enjoy will be largely lessened. Because of this, I believe that having at least six months of expenses in cash is crucial. This amount will likely change as I get older. I believe in increasing a cash buffer as you get older due to any medical issues that may arise.

It would also be nice, in my opinion, to have some money in the bank to fund things like a vacation or an outing that you don’t usually plan on. Once you’re no longer working it may be easier to find things that seem exciting that fall outside the usual budget. These things should be limited, however.

What’s your opinion on an emergency fund? Do you have one? Do you think it should be larger than what I listed above? Share your thoughts.

Thanks for reading. 

Comments

  1. says

    Mantra,

    Personally I think this is one of the best articles you’ve written. Well done. A lot of detailed, actionable advice in here, that cover nearly all aspects of an emergency fund analysis.

    I currently don’t have an emergency fund (completely leveraged myself with the August stock purchases), but also don’t see the need to have a large one right now either. Thankfully I have very steady employment and insurance coverage right now. Once I attempt to rent our house, I’ll definitely need a few months to cover a potential vacancy though.

    Great article again,

    DividendPartisan

  2. says

    Hi Mantra,

    Thanks for this post! I’ve been waiting to get your thoughts on an emergency fund (I’ve asked about it in earlier comments).

    I currently keep a 12 month emergency fund and am thinking to increase it further to 24 months. I own a home and it’s such a large expense. I also work in Silicon Valley in the volatile high tech field where jobs come and go (although it’s more likely to go) like the waves of the ocean. I am always in fear of losing my job. Sometimes I do feel like I’m overdoing it with 12 months of cash as I am so tempted to purchase more and more dividend growth stocks; but I stick to my guns. I am fortunate to have found a community online with great contributors such as yourself that helps me find good investments.

    As for your emergency fund, I think 4k is good as it provides you with a 4 month buffer plus minizes the amount of cash you have sitting on the sidelines. Plus you take your dividends in cash so if you deplete your 4k you’d probably have another 3 weeks or so of cash from the 4 months of dividends. My question to you (I’m sure you’ve thought about it): How “easy” or confident are you that you can find a new job with comparable pay in case of layoffs? How much money would you save by not going to your job and incurring job related expenses to make your emergency fund stretch out a little further? You may be one of those special cases where your expenses go up as you’d be at home more often (and increase your utilities).

    Great post Mantra and great to finally see your thoughts on this subject.

    Take care,

    Mike

  3. says

    Partisan,

    Thanks for the kind comments. I’m glad you enjoyed it!

    I can think of no other “job” that is secure as the one you have, so you are in a pretty unique situation where employment is all but guaranteed. Because of that, I don’t blame you for keeping a low amount of cash on hand.

    Once you start renting your home in the future, I’m sure you’ll find a comfort zone. Best of luck with that transaction!

    Best regards.

  4. says

    Mike,

    I was planning on writing an article like this at some point, but I came out with it today based on your comment and a couple others regarding emergency funds. I hope it answered a lot of your questions and provided you some helpful information.

    Keeping as much money on hand as you do probably isn’t a bad idea if your career field is particularly volatile, as it seems to be. I don’t blame you for that, especially if you feel that landing another job soon after being laid off is unlikely. It’s always best to plan for the unknown.

    As for me, I think it would be relatively easy to find another job paying similar to what I make now in my field at another dealership. The problem would be finding one in my area. I’d likely have to move. One thing that I didn’t mention is unemployment insurance. That falls in the insurance category. If I were to be laid off, I could easily get by on unemployment, as my expenses are less that what unemployment here in Florida pays. That would last 6 months. Then I could dip into cash for another 4 months. I could also let dividends accumulate and I also have my credit line. I think I could cover myself for at least a year if I were to be laid off. I find that unlikely currently.

    Thanks for stopping by and I’m glad you enjoyed the post.

    Take care.

  5. Shean says

    I got 1.5 months money sitting on my bank account. The Bank is paying 0.25% intrest :) and the Inflation is according media arounod 3-3.5%. So I should buy my Banks stocks and get solid 4-5% dividends rather than keeping in at bank hehe.

    Just joking. Cash is King and I know it since I work at Postal Service and they just announced 100 million cuts on spending. Basically they just cut peoples job.

    Tough luck for my collegues but good thing is that if you´re Union member u can get money from Union around 60% of your salary for next 24 months (500 workdays). Cut your spending and live like monk and u can survive with it.

    In turmoil times like this one should be Union member. The unemployment money you get from Goverment is like 555 € month.

    Despite there is high unemployment rate there is always free vacancies everywhere. Im not sure about US but here in Finland most people dont bother to work if getting paid under 8-9 cos after taxes and expenses to go to work your true income per hour would be 5-6. Getting Union money and staying home is better than working and getting low wage…for 500 days after that well.. there are places that pays 10€.

    Union collective labour agreement is the Bible. No more or no less.

  6. says

    I’m looking ahead about 18-24 months and a projected change of career fields so I’ve been building up my cash savings. I have 12 months of expenses in an emergency fund and am building up cash for anticipated future purchases. I make way more than I need/spend at this time so I’m taking advantage of it by investing a significant portion and storing away the rest for whatever the future might holds. Cash doesn’t return much but it is a lot more valuable to me now as I prepare to leave my current job than it was when I first started and had a guaranteed four years of income with an option for at least four more!.

  7. says

    Shean,

    I can’t really comment on the Union concerns, as that really falls outside my arena. However, with all the turmoil going on in your career field it wouldn’t be a bad idea to have some extra money in the bank just in case “the hammer drops”.

    Unstable employment could perhaps be one of the biggest reasons to have a large emergency fund.

    Best wishes and good luck!

  8. says

    Long Run,

    12 months of expenses is pretty fantastic. I don’t blame you for putting away that kind of money if you’re thinking of switching fields. You are thinking of exiting the military? Or, are you just thinking of going into a different field within the military? It sounds like you’re exiting all together and going into the civilian field.

    Either way, best of luck and it sounds like you are definitely well prepared.

  9. says

    Great post.

    I have one planned on this topic, why we want a small emergency fund – because my wife and I feel it’s important to us.

    Like a good boy scout, we like being prepared :)

  10. says

    MOA,

    Thanks for stopping by.

    Nothing wrong with being well prepared! :)

    Sometimes, that’s the best reason of all. If you can sleep at night and you have peace of mind that’s priceless. Having cash in the bank, knowing it’s your parachute if something goes wrong feels really good.

    Take care!

  11. says

    Very interesting post, Mantra.

    I’m also in the camp who thinks an EF should be tailored to each individual.

    I have $10,000 in my EF though I routinely deplete it and purchase stocks when we have corrections then build it back up. I always try to keep it at that $10,000 mark but it’s difficult when I see the “fire sales” on stocks that we saw last month.

    Over the past five years, I’ve never once needed to tap into my EF for anything other than stocks, so I take this as a sign that I might not need as substantial of a balance as someone else.

    Maybe your job is on the rocks and you’re not sure if you’ll have a job in 6 months?

    Maybe your rent is more than 50% of your current income and losing your job could jeopardize your living situation?

    Maybe you have lots of revolving debt and, if your income stream were diminished, you would start receiving calls from creditors?

    Luckily for me I have no debt and a secure income stream so an EF means less to me than it might for someone else.

    To each his own.

  12. says

    Just one more thing to add:

    If worst came to worst and I was in dire need of some cash, I could always switch my dividend stream from reinvestment to income, providing a cushion until I found another source of income. As another reader mentioned, living like a monk during this time could get me through some rough times.

    Not exactly ideal as it throws a wrench in the compounding angle (arguably, the reason why I invest), but it’s nice to have that option in a doomsday scenario.

  13. says

    Pey,

    $10k is a pretty serious emergency fund. If that helps you sleep at night…that’s all that matters! It’s nice to have that kind of cushion and the ability to tap it when stocks go on sale. It’s an interest-free loan!

    I hear you on the dividend income. I didn’t implicitly mention it, but I included it in the 70% buffer I currently have between income and expenses. My dividend income is always included in my income statements. If worse came to worse I could definitely tap into that dividend income.

    Between unemployment checks, cash, my credit line, dividends and certain expenses I could still lower I think I could easily get by for a year. Hopefully it never comes to that!

    Thanks for stopping by and adding!

  14. says

    Cash is King :) An emergency fund is sorely lacking in the Dividend Ninja plan, but it should be there!

    I think you did a great job with this article Mantra, and a nice change from the dividend articles (though I enjoy those as well).

    Cheers
    The Dividend Ninja

  15. says

    Ninja,

    Thanks. I’m glad you enjoyed the article. I try to get away from the dividend related articles from time to time, as there is more to life (and finance) than dividends and investing.

    Cash can definitely be King. I think if you can cover yourself for a year with cash, dividends, credit and unemployment insurance you’re probably in a good spot.

    Take care buddy!

  16. Anonymous says

    Good article. I appreciate that u post some articles on topics other than just dividend investing as these other topics are also important pieces of our financial planning. And ur articles like the one on buying time are important as they reflect on the very reasons for all of this. D. Monk sometimes also does this and it makes these blogs even that much more valuable.

    I once read on an ER blog a post which said his early retirement relied on cap appreciation and he kept an emerg fund of 3-5 yrs. of expenses to avoid having to sell in a down market. Interesting but I think I’ll stick w/ dividend investing.

    I’m actually contemplating 1-2 yrs of an emerg fund once I “semi-retire”. I’m wondering if this is too much but I am person that likes a thick safety net but that’s also cash that I could put in equities.

    -Rock the Casbah

  17. says

    Rock,

    Thanks! I’m glad you enjoyed the article.

    1-2 years of available cash when you are not working full-time any longer might not be a bad idea. As I mentioned, a lot of smaller problems could be handled by the buffer between income and expenses, but once that buffer is gone having a little cash on hand isn’t a bad idea.

    I struggle, as you do, on having cash around vs. being pretty close to fully invested. I tread pretty close to fully invested a lot of times, especially when the market is down. I just feel horrible about myself if I have cash earning 0%, which is actually losing money. Of course, one big emergency could make it all worth it, as having to sell equities at inopportune times could be worse than earning 0%.

    Best of luck with your EF!

  18. Justin says

    My family is frugal, so our expenses aren’t high. We keep $1000 as “emergency”, an excellent rewards credit card* for unexpected expenditures, and can draw on our brokerage accounts if all else fails.
    * paid in full every month

    • says

      Justin,

      I’m with you. Frugality is not only wonderful in that it frees up a lot of capital with which you can build income-generating assets, but it also frees you from keeping a ton of unproductive cash sitting around. :)

      We’re definitely on the same page. I keep a bit more than $1,000 these days because writing for a living can lead to uneven income, but a few grand set aside combined with substantial available credit and the backstop of a large brokerage account means it’s unlikely your ship will sink.

      Thanks for dropping by!

      Best regards.

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