Emergency Fund

[SecondCor521]

Debt of any kind will be poison if the recession morphs into a full-blown depression.

You're right. However, if inflation returns, my fixed interest rate debt will be a good thing. The pundits I read can't seem to make up their mind which is going to happen, but if you ask me a depression is unlikely. I admit freely that I tend towards relentless and sometimes unfounded optimism. I also try to remind myself that probably upwards of 90% of the pundits two years ago were not predicting we'd be where we are now, so I take their predictions with a rather large grain of salt.

*And not "minimum" living expenses; make an accounting of everything you need to get by during a typical month: rent/mortgage, all utilities, insurance, groceries, gas, auto maintenance, prescriptions, etc. If you do owe on a credit card debt and such, retire that debt now if possible.

I use the average of the last 6 months actual in Quicken. That gives me something of a cushion: When unemployed I would not have income/SS/medicare taxes to pay (currently run 18% of my expenses) but I would have job hunting expenses.

**This should be in a savings account, CD, money-market fund or such. Liquid and accessible. A high interest rate is not important. It should not be in a stock and/or bond-owning mutual fund, a variable-life policy, or anything else tricky.

I agree that it should be liquid and accessible. I don't see a problem with having a portion of it in a taxable mutual fund, particularly if the emergency fund in total is overfunded.

For example, if I figure I need 6 months of expenses at $5K per month, that's $30K required. I personally would feel quite comfortable if I had $15K in a savings account and $30K in a taxable Vanguard balanced index mutual fund of some sort. In fact, except for the specific numbers I just used, that is pretty much my current situation and I feel comfortable with it.

As always, JMHO and YMMV.

2Cor521

 

[youbet]

I guess it depends on your risk tolerance.

I could buy something like a Ginnie Mae fund for part of it because of its security and relative stability, but I for one can't consider using debt as an "emergency fund." In the right situation, taking on home equity debt may have its place, but I personally couldn't sleep at night if my "emergency fund" included a need to borrow money.

I'd agree the ability to borrow in the short term could add an extra worst-case cushion to the amount of time someone could sustain a huge expense or a job loss, but I wouldn't think of that as part of an "emergency fund." It's more like worst case access to borrowed capital.

Yes, I'd say it would depend on your risk tolerance. I'm just as uncomfortable with keeping many tens of thousands of dollars in cash for years and years as I am with the thought of having to sell, say, VFIIX while it's down 5% - 10% to cover an emergency. Keeping cash in an emergency fund you never need to use has an opportunity cost. Not having cash and having to sell a bond or bond fund or whatever while it's down a few percent has a cost too. You have to decide which is more painful to you.

I'm 61 yo and, thankfully, have never had an emergency needing more than the relatively small amount of cash I hold. All emergencies have been solved at least long enough for me to rearrange my finances to cover without selling anything at a painful loss or at great inconvience. I know this could change. Maybe I'll suddenly need $100k cash next week....... Admittedly, I'd be in a bind for most of it and would wind up selling investments at a loss and that I didn't plan of selling at this time. But, so far in life, that kind of big surprise hasn't happened. If I wanted to insure against that eventuality with a whopper emergency fund of true cash I'd have to get $100k together and bear a pretty big opportunity cost of holding it.

Ya pays yer money, ya takes yer chances......

Remember, not having a big emergency fund doesn't mean you can't cover big emergencies, it just means you may have to liquidate some investments at an awkward time or incur temporary debt.

Oh yeah, I don't consider a few $k for an unexpected car repair or that sort of thing an "emergency." I have those sort of things covered no problem. I'm talking EMERGENCY, as in $$$$$$ here. New engine for the youbet famly vehicle = minor liquidity issue for the normal budget. Needing to charter a plane to get DS home from Asia where he's fallen ill = emergency.

EDIT: one other thought...... Many of us are currently holding larger than normal cash allocations in our investment portfolios. This cash is not to be confused with an emergency fund since it's purpose is to be instantly available for investment when you decide it's the right time. However, in a true big-time emergency this cash could be grabbed and you simply go solve your AA problem later when the life or death crisis has passed.

 

[ERD50]

It's naive and an oversimplification to think of an emergency fund as being only cash.....

Here's an example. If I had a significant position in the Vanguard GNMA fund and a HELOC lined up on the house, I'd probably keep no more than 3 or 4 months of expenses in true cash. If all my investments were in volatile equities and I was a renter, I'd probably keep a year or more in true cash.

Thanks, saved me some typing

But last September we stopped paying any extra on debt and saved it all instead. When he signs his contract we will pay off a $6000 credit card ....

Isn't this a non-helpful "shell game" to say you have an "emergency fund" while you have credit card debt?

Why would anyone "save" money in a low interest rate savings account while they have outstanding CC debt? This makes no sense to me.

Let's say I have that $6,000 CC debt, and I "save" $5,000 and put in a savings account. Do I feel good because I have a bank statement that says I have $5,000? I'm kidding myself.

So let's say I apply the $5,000 to the CC. I wipe out some CC interest and I'm ahead of the game. Am I "poor" because I don't have a bank statement that says I have $5,000 even though I have $5,000 less in "bad debt"? No.

OK, so an emergency comes up, a $1,500 car repair. Take it from savings, and you still have the $6,000 CC debt. If you have no savings because you paid down the CC to $1,000, put it on the CC. You are still ahead with only $2,500 CC debt and no savings.

Unless your CC company does not charge you interest. Then never mind

-ERD50

 

[ERD50]

Keeping cash in an emergency fund you never need to use has an opportunity cost. Not having cash and having to sell a bond or bond fund or whatever while it's down a few percent has a cost too. You have to decide which is more painful to you.

And since bond funds go up *and* down in value, there is a reasonable chance that if you had to liquidate some, it would be above what you paid. No pain at all.

People seem to keep looking at that non-cash "emergency fund" in the "glass half empty" view. Heck, if that is the case, we should always be in cash all the time with all of our investments. OK, sounds pretty good the past few years, but see where FireCalc gets you with all cash.

-ERD50

 

[Bimmerbill]

I had a decent little emergency fund saved up but recently decided to pay off as much of my debt as I could. I listen to Dave Ramsey and sort of follow his plan, but don't do the zero based budget.

I work for the fed gov't, so no chance of me being suddenly laid off. If layoffs were to happen, there would be a lot of warning as well as programs to find me another position. If all else fails the job has a pretty hefty severance.

I am close to paying off all of my non house debt tho and will build up a cash cushion once that happens.

 

[W2R]

And since bond funds go up *and* down in value, there is a reasonable chance that if you had to liquidate some, it would be above what you paid. No pain at all.

People seem to keep looking at that non-cash "emergency fund" in the "glass half empty" view. Heck, if that is the case, we should always be in cash all the time with all of our investments. OK, sounds pretty good the past few years, but see where FireCalc gets you with all cash.

-ERD50

I was thinking along the same lines yesterday, while sitting on an unreasonably high pool of cash (12+ years expenses in MM).

In fact, I agreed with you so much that I took 1/4th of it and bought VBMFX (Vanguard Total Bond Fund). I did the computations and it looks like I would have been slightly ahead by now if I had put it into VBMFX last July instead of MM.

I intend to move considerably more out of MM and into bonds at some point fairly soon.

 

[ziggy29]

Why would anyone "save" money in a low interest rate savings account while they have outstanding CC debt? This makes no sense to me.

Let's say I have that $6,000 CC debt, and I "save" $5,000 and put in a savings account. Do I feel good because I have a bank statement that says I have $5,000? I'm kidding myself.

So let's say I apply the $5,000 to the CC. I wipe out some CC interest and I'm ahead of the game. Am I "poor" because I don't have a bank statement that says I have $5,000 even though I have $5,000 less in "bad debt"? No.

OK, so an emergency comes up, a $1,500 car repair. Take it from savings, and you still have the $6,000 CC debt. If you have no savings because you paid down the CC to $1,000, put it on the CC. You are still ahead with only $2,500 CC debt and no savings.

But what if you pay off the CC and then they slash your credit line to the bone at the same time you lose your job (and thus losing access to more credit)?

In a terrible job market there's no substitute for liquidity in the form of real cash in the bank -- not just potential cash that can be raised by future borrowing. Having said all that, I'd be inclined to use as much extra cash flow as I could to pay down the CC -- but I wouldn't cut my cash savings to the bone in this economy unless I had a ridiculously secure job or income stream.

 

[ERD50]

But what if you pay off the CC and then they slash your credit line to the bone at the same time you lose your job (and thus losing access to more credit)?

OK, I guess that is a possibility. So I guess some cash could make sense, even with the CC debt.

I still think it is a little strange to think of it as "savings", when the bad debt is sitting there to offset it.

-ERD50

 

[ziggy29]

I still think it is a little strange to think of it as "savings", when the bad debt is sitting there to offset it.

Perhaps "reserves" would be a more appropriate word for this situation.

 

[FIREd]

I have just about 2 years worth of expenses in what I would consider my emergency fund. I don't have a Suze Orman-style dedicated emergency fund anymore, i.e. 8 months in cash sitting in a FDIC-insured savings account, but rather just a bunch of money sitting in more or less stable investments which can be tap very quickly.
My "emergency fund" includes cash sitting in money market funds and CDs (4 months-worth of expenses) but also and mostly money sitting in a short term muni bond fund (4 months) and an intermediate term muni bond fund (16 months).

 

[se012101]

Dave Ramsey says that your "baby emergency fund" should be $1000 until you get out of debt.

I think that is totally crazy. If a person so much as misses a single paycheck, they are in serious trouble. Paying down debt is important, but there is a sensible middle point of aggressiveness depending on the security of a person's job, and also on the number of people depending on them. A person's comfort and lack of worry also has a value, though it is hard to quantify in dollars and cents.

My wife and my philosophy is to decide on the magic number, for us it's 12k, representing about 3-4 months expenses (though w/ the house and one car paid off, we could stretch it out to 6 months) and simply reprogram ourselves to consider that to be the zero balance. Could that 12k have earned or saved us something over the years? Sure! But to us what it could earn is a reasonable amount to pay for a bit of peace of mind, no matter how eager we are to pursue our financial goals.

 

[Bimmerbill]

I agree about having a bit of cash in the bank. I keep a bit extra in my accounts over and above what I use to pay monthly bills and really want to get back to a dedicated emergency fund.

A lot of the Dave Ramsey folks are seriously cash poor. For a lot of them the $1000 represents A LOT of money and takes months to save up. This is even true for some of the high wage earners!

Heck, I just hit my garage with my car and need to fork over my $1000 deductable. Its gonna hurt!

 

[ziggy29]

Heck, I just hit my garage with my car and need to fork over my $1000 deductable. Its gonna hurt!

It would have hurt worse if you had my homeowners insurance. My deductible is 2% of the insured value -- currently about $2,700 based on replacement value...

 

[Alan]

I use the average of the last 6 months actual in Quicken. That gives me something of a cushion: When unemployed I would not have income/SS/medicare taxes to pay (currently run 18% of my expenses) but I would have job hunting expenses.

You would also, probably, have a big increase in Health Insurance. I pay $80/month in Health insurance premiums through work - DW is ESR'ed so no option of employer insurance there. If I lose my job, COBRA would cost >$700/month as we still have an excellent plan at work. 90% of people that lose their jobs don't take up COBRA and go uninsured because they simply can't afford it.

 

[ziggy29]

COBRA would cost >$700/month as we still have an excellent plan at work. 90% of people that lose their jobs don't take up COBRA and go uninsured because they simply can't afford it.

In the general case, true, but I believe that recent laws will leave Uncle Sam paying 65% of COBRA for up to nine months for folks laid off through the end of 2009.

 

[Alan]

In the general case, true, but I believe that recent laws will leave Uncle Sam paying 65% of COBRA for up to nine months for folks laid off through the end of 2009.

True, a 9 month hiatus.

 

[kumquat]

But what if you pay off the CC and then they slash your credit line to the bone at the same time you lose your job (and thus losing access to more credit)?

Isn't it more likely that your CC limit will be lowered if you carry a large balance? I've never rung up more than 50% of my limit and usually pay it monthly (most months I don't use it so occasionally I forget and pay interest on a couple of hundred). Credit is most easily available to those who don't need it.

 

[Rustic23]

As stated an emergency fund is to be used in case you loose your job. So you could look at it am my emergency fund is = to my salary X the number of months I expect to be without a job + a fudge factor. My spouses would be the same. Now we may be out of a job for a different amount of time. If I am a financial analysis for say a wall street firm, it may be 24 months, but my spouse a hamburger flipper at Mickey D's. maybe two weeks. The amount of time and the amount of cash would depend on how much we bring into the relationship, and how long we expect to be unemployed.

 

[Bimmerbill]

It would have hurt worse if you had my homeowners insurance. My deductible is 2% of the insured value -- currently about $2,700 based on replacement value...

I insure my house and car with USAA. So, I could have been hit a $1K deductable for the car, and a $1K deduc for the house!

Luckily the house is fine. Just my pride and my car damaged.

 

[Sue J]

Originally Posted by Sue J
But last September we stopped paying any extra on debt and saved it all instead. When he signs his contract we will pay off a $6000 credit card ....


Isn't this a non-helpful "shell game" to say you have an "emergency fund" while you have credit card debt?

Why would anyone "save" money in a low interest rate savings account while they have outstanding CC debt? This makes no sense to me.

Let's say I have that $6,000 CC debt, and I "save" $5,000 and put in a savings account. Do I feel good because I have a bank statement that says I have $5,000? I'm kidding myself.

So let's say I apply the $5,000 to the CC. I wipe out some CC interest and I'm ahead of the game. Am I "poor" because I don't have a bank statement that says I have $5,000 even though I have $5,000 less in "bad debt"? No.

OK, so an emergency comes up, a $1,500 car repair. Take it from savings, and you still have the $6,000 CC debt. If you have no savings because you paid down the CC to $1,000, put it on the CC. You are still ahead with only $2,500 CC debt and no savings.

Unless your CC company does not charge you interest. Then never mind

-ERD50

Yes, my CC card company does not charge me interest. It's on a 12 month 0%. The minimum payment is $100 a month on about $6000. We have the money and will pay it off as soon as DH signs his contract. It would have been paid off by now but if he lost his job that $6000 would cover more than 2 months of living expenses and with such a low minimum payment right now I'd rather have the cash in the bank.

This is the last hunk of debt left on a CC used for my son's college expenses. He was in college from 2002 to 2006 and we would pay what we could from savings and put the balance on a 0% charge card. In 2002 they were 12-18 months and I never paid a balance transfer fee. When the 0% would expire, I'd get another intro card and transfer again. Now, it's rare to find a 0% without a BT fee, so I'll be glad to be done with this very soon.

All in all not a bad way to borrow for a college education. Almost 7 years and never paid any interest.

 

[ERD50]

Yes, my CC card company does not charge me interest. It's on a 12 month 0%.

In that case - Nice work!

-ERD50

 

[Nords]

A lot of the Dave Ramsey folks are seriously cash poor. For a lot of them the $1000 represents A LOT of money and takes months to save up. This is even true for some of the high wage earners!

Suze was on Oprah last week with some advice that only makes sense if you're already in serious debt trouble and maybe one circle away from going down the drain.

Suze said that if you're laid off and get some sort of lump-sum severance, you should not use the severance to pay off your credit-card debt.

Note: It took my spouse a long time to get me to understand the implications of that last statement. First, these people have credit-card debt that they're not paying off every month. Second, the amount of debt that they have on the card is near the card's limit and they're not able to get new cards to transfer the balance. Third, it's been this way for a long time-- months at least, maybe years. So they've been paying thousands of dollars of monthly interest charges as a way of life. OK, having said that, back to the story.

You would think that Suze was advising you to save the severance money to keep paying the mortgage or buying groceries, but she had an additional reason.

The twisted logic behind her precaution is that the credit-card company is keeping an eye on your balance because it's so close to the max and hasn't made much payoff progress. You're on their radar. If you knock that balance down with a big slug of cash, the credit-card company's risk managers understand that the statistical probability is severance money by newly-unemployed people who are about to stop paying their balance or getting ready to go on a serious shopping spree. So, as soon as the computer recognizes what's happened, it'll reduce the card limit by the amount of the paydown. If they time it right, you'll overspend your new (lower) limit before the reduction notification reaches you, which means that you'll be subject to additional over-limit fees and a higher interest rate.

Suze's advice was to keep paying the minimum fee on the monthly balance (which includes a high interest payment) so that you could still have a couple thousand dollars' overhead if you needed it. Of course you were expected to cut all your other expenses to the bone-- no cell phone, no cable, no broadband, no satellite radio, no car lease, and so on.

Her other "twisted logic" advice was to continue to let the kids go to their private school and their activities (so that you wouldn't totally disrupt their lives and add stress to your job search) but to cut off all other unecessary spending.

So, in summary, she expected the newly unemployed to continue to pay the carrying charges on credit-card debt and to be able to let their kids continue their normal lives (sans cell phones or cable TV or other extras but still with school & activities)... but to cut back in all other areas.

No wonder she's raised her eight-month recommendation to 12 months.

I guess this only applies to people who have been living so large for so long that they've nearly maxed out all their credit and have plenty of excess spending to cut out. I can't imagine the monthly expenses of $7000-$8000 that some of these people have achieved.

Suze also suggested that couples should attempt to live on one wage-earner's income instead of spending the extra paycheck. Oprah asked the audience how many people could do that, and about 10 hands went up. When it became clear that Suze meant "for a year, not just a month", there were zero hands up.

No wonder I don't watch Suze or Ramsey. I can't relate to their audience...

 

[NW-Bound]

No wonder I don't watch Suze or Ramsey. I can't relate to their audience...

I never heard of Ramsey until I frequented this forum, and still have not seen or read him. Yes, I have watched Suze a few times and, as you said, there is an audience for her, and she fulfills that need. Because of that, I do not knock her.

 

[Moscyn]

It's naive and an oversimplification to think of an emergency fund as being only cash.

What you need is an emergency plan. How would you replace your income if you lost your job or how would you pay for emergency purchases that are above your income? The answer might be some cash in hand but could also include investments liquid enough and stable enough that they could conveniently be converted to cash before your actual cash is depleted. Or it could be some sort of line of credit.

Here's an example. If I had a significant position in the Vanguard GNMA fund and a HELOC lined up on the house, I'd probably keep no more than 3 or 4 months of expenses in true cash. If all my investments were in volatile equities and I was a renter, I'd probably keep a year or more in true cash.

How does one view rental income? Should be liquid enough since tenants sign a fixed year lease. How liquid is a fully paid house in this market (assuming you have another house you are staying in and the second house is not rented out). Can one take a certain % of the value of that house as emergency fund on the assumption that you can always use it as collateral or sell it within the year at a reduced price if needed?

 

[Zoocat]

Suze also suggested that couples should attempt to live on one wage-earner's income instead of spending the extra paycheck. Oprah asked the audience how many people could do that, and about 10 hands went up. When it became clear that Suze meant "for a year, not just a month", there were zero hands up.

No wonder I don't watch Suze or Ramsey. I can't relate to their audience...

I saw that show too and assumed (maybe wrongly) that the audience was responding based on their current budget. They hadn't had time to figure out how much they could reduce their spending so they couldn't know whether they could make it on 1/2 for a year.

But it is telling that, based on their current spending, they couldn't cut by half. I think that's probably true for most of us. I would have to sell my home to cut my spending by half.