Too much emergency fund?

[Fizgig]

Hello all, I'm grateful to be able to ask this question, but am I hoarding too much in my emergency fund? I'm torn between bumping it up just a little, or aggressively paying down the mortgage on a rental property. I just changed jobs and moved out of state, and there's a chance that my job will end in June 2012 (am dependent on government funding). My industry is in severe flux right now and I want to be prepared for a potentially long job search, without being stressed out or desperate.

33 years old, single

Income:
$4000/mo Salary, take home
$1275/mo Rental Income

Monthly expenses:
$2700 (includes expenses for rental property)

Assets:
$41k savings, 0.9% interest
$90k retirement funds
(Note - I am not eligible for my new job's 401k until next year. Am putting $5k/year into my Roth for now.)

Debt:
$91k Mortgage, 5.5% 30 year fixed (23 years remaining, home value ~$135k)

I'm thinking about retaining $40k as an emergency fund (12 months expenses + 20% pad), and putting $2k/month towards the mortgage. The home is in Houston, TX and I now live in Boulder, CO, but I chose to keep the home because it has a garage apartment. If life throws me serious lemons I can live there for free and even earn some cash in the deal. It is in good hands and if it ends up being a hassle, I will sell it. I cannot realistically afford property in Boulder and will rent cheaply for the foreseeable future.

Just wanted to get some thoughts on my plan - many thanks for your insight.

[MonkeyMama]

I am personally a believer in big emergency funds. I don't see anything wrong with a $40k emergency fund.

I'd personally bump up retirement saving to 15% (or more) of gross salary. I assume $5k to ROTH is not even 10%. Though I understand you can't tax shelter above the ROTH at this point, you can set money aside in taxable accounts. (That said - I think it's fair to skip that for now and wait until the 401k comes available. There is a huge simplicity to not having to deal with taxable accounts. I only recommend this if you commit to funding your 401k later).

On the mortgage - how quickly do you think you can pay it off? Though I generally would not advise tying up that $2k/month in a mortgage, you are young and with that strategy you can probably pay it off VERY quickly. I say, go for it. I presume you would redirect that money to investments/retirement, once you knock out the mortgage. I personally wouldn't tie up that liquidity or sit out the investing for very long, but 2-3 years, while young, is a solid plan.

[Fizgig]

Thank you for your comments!

Yes, I'm very irritated about the retirement situation. Once it kicks in it's quite generous (I put in 5%, they put in 10%), but I hate being on pause for this year. Annual contribution limits are $5000 total for Traditional or ROTH IRAs, so I'm already maxed as to what I can kick into retirement accounts. I will absolutely use my employer's 401k the exact minute I become eligible, presuming I'm still employed there! I've thought about investing separately in just a regular brokerage account in the meantime, but yes the hassle factor with capital gains and such makes me hesitant.

At $2k a month, I can pay off the mortgage in roughly 4 years. If my drop my EF to something less conservative ($25-30k), I could pay it off in just under 3. Any windfalls I might receive in the meantime would go there as well, so it might pay down faster.

[disneysteve]

Even with a potential job loss a year from now, I think you're sitting on too much cash. A 1-year EF isn't such a bad idea but that would only be $32,400 (I don't think the 20% extra is necessary). And you definitely don't need to keep it all in a 0.9% account. Get some laddered CDs or maybe even a short-term bond fund that won't be too vulnerable to rising interest rates.

The other comment concerns your retirement savings. It sounds like right now you are only doing the 5K/year into the Roth. That isn't nearly enough. You should aim for 15% of your gross annual income. I'm guessing that's somewhere around 12K/year for you. I would look into opening a non-retirement investment account that you personally earmark for retirement.

[Fizgig]

Yeah, I'm starting to agree about the regular investment account. That $7000 shortfall, even for one year, would be $100k less at retirement at an 8% rate of return. I can slow down on the mortgage repayment and funnel some of that cash into non-retirement mutual funds.

I'll consider more options for where to house my EF. CD rates aren't that attractive, either.

[KTP]

I think I would ladder your emergency fund into I-bonds if I were you.

This is the last year you can easily buy paper bonds, so you can do $10,000 total this year.

Next year you can only buy the electronic version unless you arrange your tax refund to be huge (paper I-bonds can be purchased with tax refund). So next year $5000

Can't touch the money for one yar, but after that you only pay 3 months interest as a penalty. After 5 years you can cash them in with no penalty.

You can wait until Oct. to see what the new issues will be paying. Right now they are paying 0% fixed, 4.6% inflation rate, which gives an overall rate of 4.6%...so much better than a CD. Maybe a downgrade in US credit will get the fixed portion up to 0.5% or so in October, so I might suggest waiting.

$10,000 this year would leave you with $31,000 in your EF. Next year buy $5000 more, etc. etc. The interest acrues tax deferred!

[MonkeyMama]

Just to clarify - if you wanted to skip the PITA factor of the taxable accounts, I was thinking more along the lines of putting in $14,000 next year. (Say, skip the $7k this year, but double up next year - in 401k). Just to clarify.

I certainly won't discourage you from just investing in a taxable account until you have other options.

[Frugal]

I don't think you can ever have a savings account that is too large. Personally, if I was in a good job with a relatively high or moderate risk of losing it in a year, I would be driven to save even more!

[nick__45]

Originally Posted by Frugal

I don't think you can ever have a savings account that is too large. Personally, if I was in a good job with a relatively high or moderate risk of losing it in a year, I would be driven to save even more!

That makes 2 of us who feel that way. I am not sure where people get the idea that 6 months to a year is adequate emergency fund to shelter from job loss. The only people I know that can get a new job comparable to what they're doing are either highly skilled (real skills and not some easily replaceable office monkey) or people making under $10/hr at a retail store or waiting table or something that have high turn-over. For the rest of the population, it could take more than a year to get a new job after a job loss, aka fired or laid off.

I was so glad when I got my contract renewed for 10 years earlier this year. I was crapping bricks each minutes for 2 years prior to the contract renewal. In five years, I'll get my tenure and contract renewal should be walk in a park. I feel bad for people that loose their nice jobs and struggling to stay above water. Without the extended unemployment checks, those people would be on the street by now.

[disneysteve]

Originally Posted by nick__45

That makes 2 of us who feel that way. I am not sure where people get the idea that 6 months to a year is adequate emergency fund to shelter from job loss. The only people I know that can get a new job comparable to what they're doing are either highly skilled (real skills and not some easily replaceable office monkey) or people making under $10/hr at a retail store or waiting table or something that have high turn-over. For the rest of the population, it could take more than a year to get a new job after a job loss, aka fired or laid off.

In the current economy, this is a very valid point. It justifies a much larger than usual EF. More importantly, and this is where many people falter, it justifies trimming expenses wherever possible - not just after the job loss but today while you still have the job. That accomplishes two things. It frees up money to use to build the EF and it reduces your monthly expenses which makes the EF last longer.

Personally, I fall into that highly skilled category. I could have work within a week or two if I lost my job tomorrow. So for me, a 6-month EF is plenty.

[LivingAlmostLarge]

Also when you budget an EF, realize 6 months can also last a year with unemployment, second income (partner working), and trimming the budget. What people don't realize is the regular budget is very generous probably.

If we lost a job, we'd cut eating out, entertainment, etc. We would likely keep internet for job hunting, but we would really look to decreasing our groceries, driving, etc. Lots of small things we could probably trim another $1k off our spending now. We'd not pay for things like home repair, cleaning, etc. We would have more time to do it ourselves.

[Fizgig]

UPDATE:

I talked to HR about my retirement options, and although I am not eligible for their most generous plan (I put in 5%, they put in 10%) until one year of employment, I AM immediately eligible for a non-matching 403(b). At least I'll get a tax break until the match kicks in. So, between my Roth IRA and the 403(b), I will save 15% of my gross starting this month.

PLAN:

1) I will keep my EF overfunded at $40k, for piece of mind. That will last me well over a year at regular spending levels and with no tenants, but probably more like 3 years with the house rented and unemployment, should it come to that. That will keep me in a warm fuzzy place emotionally. I am highly skilled but also highly specialized (aerospace engineer), and it could take time to find a job *I* want, not just one that wants me. I won't work defense and that limits my options greatly.

2) Invest 15% of my gross, swap to the generous plan once eligible and fund at the same level, so the 10% employer contribution is gravy.

3) Put $1000 extra per month towards the mortgage on the rental property, which will pay it off in ~5 years. Any windfalls will be applied to the mortgage, so hopefully it'd be paid off faster than that.

Thanks for your comments, all - Without this thread I probably would have "ho-hummed" over the retirement situation rather than seek out other options, so I'm grateful.

[disneysteve]

Originally Posted by Fizgig

That will last me well over a year at regular spending levels and with no tenants, but probably more like 3 years with the house rented and unemployment

Your EF should be based on the worst case scenario, so that would include no tenants and having to cover the rental property costs yourself.

[Fizgig]

Originally Posted by disneysteve

Your EF should be based on the worst case scenario, so that would include no tenants and having to cover the rental property costs yourself.

Agreed, which is exactly what I based it on.

[bjl584]

Originally Posted by Fizgig

UPDATE:

I talked to HR about my retirement options, and although I am not eligible for their most generous plan (I put in 5%, they put in 10%) until one year of employment, I AM immediately eligible for a non-matching 403(b). At least I'll get a tax break until the match kicks in. So, between my Roth IRA and the 403(b), I will save 15% of my gross starting this month.

PLAN:

1) I will keep my EF overfunded at $40k, for piece of mind. That will last me well over a year at regular spending levels and with no tenants, but probably more like 3 years with the house rented and unemployment, should it come to that. That will keep me in a warm fuzzy place emotionally. I am highly skilled but also highly specialized (aerospace engineer), and it could take time to find a job *I* want, not just one that wants me. I won't work defense and that limits my options greatly.

2) Invest 15% of my gross, swap to the generous plan once eligible and fund at the same level, so the 10% employer contribution is gravy.

3) Put $1000 extra per month towards the mortgage on the rental property, which will pay it off in ~5 years. Any windfalls will be applied to the mortgage, so hopefully it'd be paid off faster than that.

Thanks for your comments, all - Without this thread I probably would have "ho-hummed" over the retirement situation rather than seek out other options, so I'm grateful.

You seem to be on the right track. There is nothing "wrong" with having a large EF. Many people will tell you that having too much cash cuts into your ability to make your money work for you. And, it does. Earning 8 to 10% in a mutual fund is better than earning 0.9% in a money market fund. But, cash can be a very powerful tool. Having a large amount of liquidity can open up a lot of opportunities for you. It just depends on your position in life and in your near term plans. I think that stopping at $40K and shifting to investing your money should serve your needs well.

[danieldroga]

There's nothing to worry about saving to much emergency fund. This will be helpful for you in time that you need money. So the more, the better for your future use.