Quote:
Originally Posted by JinCO
jIM_OHIO - the 6% number was just used in my model, not based on actuals. I was trying to be conservative when forecasting but I will move it to 8% for now and track the results.
12 months seems like a pretty hefty emergency fund. We do have some levers to work with if one of us lost our jobs. $2600 in child care costs would go away right of the bat. We could also reduce / eliminate $401K investing. We could also reduce "overpaying" our mortgage and HELOC. Student Loans could be deferred. The bottom line is that we could live off of one salary if we needed to.
If both of us were to lose our jobs at the same time, we would have about 6 months to find new jobs based on severence, unemployment and current savings. I understand that the concept of the EF is planning for worst case scenarios, but shouldn't you also factor in the liklihood of the emergencies occuring. I would think you would want to carry a higher EF if you were relying on one income because there is a single point of failure or if you felt there was a risk of losing your job.
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I tier my EF into 2 layers.
The first layer is the cash layer. I have 3 months expenses in CDs. Three 90 day CDs, each CD maturing 30 days from the previous or 30 days before the next one.
The second layer is the stability layer (for mid term expenses, emergencies and similar). I invest this in PRPFX, which has double/triple the return of the CDs, and the risk profile of the investment suggests it will rarely lose money (year over year).
The second layer for me is also where deposits go for the following:
1) kids college savings
2) new car fund
3) any mid term expense such as a vacation in 3 years, new roof, or similar.
I might suggest you tier your EF to be the following:
1) calculate one months expenses if a spouse was NOT working. Set aside 3 months of this value in a cash based investment.
2) set aside months 4-12 of the same number in a more growth oriented investment.
3) set aside an additional amount based on two spouses not working (maybe 3 months total expenses).
Logic being:
Cutting back is a way to make 3 months expenses become 6 months. It is not how I would plan to handle a short term problem. What if your child gets sick and both spouses need to leave work for a short amount of time? What if spouse A gets sick and spouse 2 loses job? If you planned on cutting back to get budget in line with income, you are living "paycheck to paycheck". If you have cash set aside, the cutting back just allows that cash to go further.
In an emergency, cash is king. Cutting back is overrated and means you have not saved enough.
I am never surprised when this board blindly recomends to pay off debt... but I think in your case most people do not see the tax situation here. Your income suggests a tax plan is more important than a managing debt plan. Good thing the board's advice is free. That tax plan will probably suggest keeping debt (such as a mortgage) where you can write off a portion of the interest. You could probably also create your own business (of some sort) to get even more writeoffs. The tax plan will save you more than the interest you pay every year in student loans.
When doing the planning (projections) of net worth, you need to have an end goal in mind. Might be the day your child goes to college, might be the day both spouses can retire, might be the day a research project ends. That end goal is where
a) you need to know net worth
b) you need to know value of investments
c) you need to know how much debt you still have
d) you need to know monthly expenses
I would then work backwards. Are the expenses you have today close to the expenses you will have at that date?
What would it take to have debt paid off by that debt? If date is far enough out, the debt might go away quietly on it's own. If date is real soon, the debt needs to be paid off aggressively.
If the investments do not cover the expenses, you need to adjust the debt pay down previously to make sure an 8% (or x%) growth rate gets the needed investment balance.
If the net worth covers the expenses (but investments do not), consider reallocating the debt payoff structure (similar to previous step) to make sure you have liquid cash to cover real expenses.
Because there are so many unknowns when doing this, you need to be conservative in some ways, optimistic in others, and plan for many situations.
For example: what if you invested instead of paying down the debt. If your total debt load is 800k (500k house, 300k student loans), maybe you invest until you have enough set aside to pay off the debt. Then once you have the debt balance set aside (so net worth is zero), start paying off the debt. letting the money which had been set aside keep growing.
In this case you kept liquid funds when risk was high (high debt is high risk). Once you crossed the point where you are worth more than your debt, you pay off the debt to lower your risk, while you still have the liquidity to solve other problems if needed.
This is my plan (for me) more or less. Keep cash on hand growing faster than my debt. Once I can pay off my $325k mortgage with cash on hand, I will stop setting aside extra payments in an investment, and start making real extra payments to the debt. I keep my liquidity (which is my primary goal when dealing with debt), while also working towards time timeline which has me retiring the year my oldest graduates college (57) or high school (53).