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investing fundamental #4 – emergency fund

by retirebyforty on October 20, 2010 · 21 comments

in retireby40's investing fundamentals

flickr - zawtowers

When I first started out, I thought, “Why do I need an emergency fund?”  I’d rather invest that money in stock and put it to work.  If I really need money, I can use a credit card or sell the stock.

If all goes well, then I won’t need to use that money and I can make some profit from stock. However, I also need to look at the worse case scenario.  Let’s say I need money to fix the car so I put the repair bill on the VISA card.  Then stock is down so I lose money when I sell my shares. The result is:  I can’t pay the credit card bill in full and need to carry the balance.  A credit card balance is a slippery slope that we need to avoid.

Experts recommend having 3 to 6 months worth of living expenses in your emergency fund. I think 2 to 3 months is a good starting point for young people. If you are older and have more responsibilities, then it needs to be closer to 6 months in case you lose your job or are confronted by some other emergency.  You can figure out how many months of living expense you should have covered for your situation, then bring out your handy budget sheet and you’ll have your target emergency $.

This emergency fund is for emergencies — hence, the word ‘emergency’ — and should be put in a separate saving account so it is easy to auto deposit and is accessible when you really need it. The target amount will look very daunting if you are just starting the emergency fund. You just need to start small and save away a bit every month and stick to it.  Even $10 a week will be a good start.

I must confess, our emergency fund is a bit low at the moment.  We had about five months worth of living expenses saved into our emergency fund.  Then, our car broke down and we had to purchase a vehicle, so that drained our emergency account. Financially, this is the biggest priority for me at the moment. We are at about 2 months right now and it’ll take at least 8 to 10 months to save back up to our target.  I’ll probably sell some stocks in Q4 and redirect some of the earnings to the emergency fund. We’ll revisit this topic again at the end of the year to check how I’m doing. My target is 6 months, but we have a dual income so maybe the time can be reduced to 4 months.

Do you have an emergency fund and how many months of living expenses would it cover? Are you an investor and do you agree with the whole emergency fund concept? It seems many investors would rather put the money to work.  Also, let me know your opinions on the whole dual income adjustment.

retirebyforty’s personal strategy
– Emergency Fund should be in a high yield bank saving account where one dollar is worth one dollar and I can withdraw anytime.

-Put money in the emergency account before other investments. (Except employer match 401k, which is free money.)

– If emergency account runs low, replenish by saving and liquidating some investments.

related posts
5 reasons to have an emergency fund at Invest It Wisely

How much saving should you have? at Money Green Life

{ 17 comments… read them below or add one }

Invest It Wisely October 20, 2010 at 8:04 am

I agree with the emergency fund concept, and I also think that one to two months is fine for younger people. As responsibilities increase, this can be ramped upwards. I also think that maintaining a healthy gap between income and expenses is even more important than the emergency fund and provides more security. I would not liquidate investments to replenish the emergency fund (since that can always be done if there is an actual emergency); that’s another reason why I’d want a healthy gap because I could easily replenish out of income.

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retirebyforty October 20, 2010 at 11:18 am

I agree with you on maintaining a nice positive cash flow, it is the basis of building wealth. I must be getting a bit more conservative as I get older and I am putting a higher priority on the emergency fund these days. I’m going to liquidate some stocks in Q4 anyway to rebalance and take advantage of the lower 2010 capital gain tax. It’s a good time to redirect some of those money to the emergency fund.

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Invest It Wisely October 21, 2010 at 9:17 am

Thanks for mentioning my post! :)

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retirebyforty October 21, 2010 at 12:37 pm

I’m going to add links to similar topic so I can keep track of as many point of view as possible. ;)

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Everyday Tips October 20, 2010 at 10:09 am

I have about 2 months expenses, and also a HELOC that just sits there in case I really need a huge amount of money. (I don’t want to use the HELOC, but it is there just in case. We had taken out the HELOC for some remodeling, but we paid it off pretty quick. It is free to keep the account open, so it just sits there, waiting.) We also have some mutual funds and such we could see if we had to.

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Squirrelers October 20, 2010 at 4:13 pm

I agree with you on the need to have an emergency fund. It’s there for true emergencies, as opposed to foreseeable problems like car issues, basic medical needs, etc.

Now, in terms of number of months expenses, I’m more conservative this way. As in, more months of expenses to be saved. I like the idea of 9 to 12 months. You just never know what could happen, and it’s best to be prepared.

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retirebyforty October 20, 2010 at 6:27 pm

Thanks for your input. I am getting more conservative as I get older, but 9 to 12 months is too much for me. I’d rather put anything over 6 months to work. ;)
Everybody has a different point of view and it’s great to read about them.

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Charles October 21, 2010 at 12:24 pm

I don’t like to use the term emergency fund savings. I just like to have ONE savings. They can be allocated to stocks, bonds, online savings, CDs, or whatever. As long as they can be liquidated rather quickly, it doesn’t matter where your money comes from when you need them.

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retirebyforty October 21, 2010 at 12:34 pm

Ok, I see your point of view. I added a link to your post in the main body as well. I suspect many if not most investors think like you. I also used to think if they can be liquidated quickly, it should be ok.
After living through the great recession, I’m seeing that cash is king!
The problem is stocks, bonds, mutual funds are volatile and you may not be able to get the money out when you need it. What happens if you needed your saving on Feb. 9th, 2009 – at the bottom of the stock market? You just lost a lot of money liquidating your stocks.
Remember when the money market fund dropped? Many people can’t withdraw their “saving.”

For me, the emergency fund needs to be in a high yield saving account where one dollar is worth one dollar. I’m sure I will learn more from all the PF blogs.

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Aloysa October 21, 2010 at 8:48 pm

We are working on the emergency fund. Well, we are working on a lot of things at the same time – debt, student loans, vacation fun, pet fund and emergency fund. Pretty much in this order. It is sad because emergency fund should be our priority. Well… we will get there.

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Joe Plemon October 22, 2010 at 6:47 am

I agree with you that the emergency fund needs to be set aside simply for emergencies. The problem of co-mingling with other funds, as Charles suggested, is that keeping track of exactly how much of that one fund is for emergencies. It would be easy to use emergency money for something else and not have it there when the emergencies happen. I like the simplicity of keeping that emergency fund in an account by itself.

BTW…good thing you had the fund in place when your car broke down. Your “emergency” wasn’t really an emergency because you had planned ahead. That is good money management.

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retirebyforty October 22, 2010 at 9:03 am

That’s exactly the word I was looking for co-mingling. :)

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ABD October 22, 2010 at 1:15 pm

I am just building up my emergency fund now (just started my first real full-time job a few weeks ago.)

In preparation, I set up a new high-yield checking account with 3.5% interest, which is higher than I could find on most savings accounts. (checkingfinder.com is awesome.) The problem with a high yield checking is that you have to use your debit card 12 times a month or something to get the high yield, so I have to use this as my spending account too. I would prefer it if the account was more out-of-sight-out-of-mind, but I can exercise a little self control to have emergency money immediately available, but earning 3.5%.

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Investing Smart November 15, 2010 at 4:21 am

Great post on How To Invest Into Your 401k! I really enjoyed reading it, and my own site is about Investing Smart so I’m not just saying so lightly. Keep up the good work!

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Barb Friedberg January 25, 2011 at 9:52 pm

Although cash (especially today) has virtually no yield. I like having a cash cushion for psychological purposes. I feel comfortable knowing that our family can handle difficult unexpected financial situations. It really increases my peace of mind. It’s worth giving up some extra yield to me!

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retirebyforty January 25, 2011 at 10:20 pm

I feel the same way as I am getting older. I used to be like Kevin Mckee @ Thousandaire and send most money into the investment account. I need more cushion now though because I’m married and baby will be joining us soon.

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Jane April 12, 2011 at 12:28 am

I would like to have safety as well as stability in old age and pension. I’ve in no way rich, except if I find a way to guess 6 figures in Lotto, however I’d want to keep my own roof above my head and also meal on the table. That security is more vital to me than anything else. Unfortunately with current pension plans I have only confusion.

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