I have trouble convincing myself to build an emergency fund

[jaine]

I think I need some advice ... I really have trouble convincing myself to build an emergency fund. I'm saving a lot but I feel so much more comfortable putting it in retirement savings. Having cash on hand makes me very nervous for some reason. Please tell me what you think ... maybe I need a reality check.

The full breakdown of what I spend in a typical year:
- 30% taxes
- 24% for my own retirement savings
- 6% helping my siblings
- 40% spent on myself

Historically whenever I have an emergency fund on hand, I have spent it on non-emergencies. The first time was a house that I would not have bought if I didn't have the cash on hand, the second was a laptop purchase that I would have postponed for another year if I didn't have the cash on hand, and the third was a car that I probably would have bought used for $10K instead of new for $18K if I didn't have the cash on hand.

Suppose hypothetically a life-and-death emergency comes up that costs $10K. I could use half of my Roth IRA (which has about 20K in it, 1/4 of my retirement savings) or I could put the amount on a credit card. Both of these options make me extremely nervous and uncomfortable - and that's why I like them better than cash. I like debt about as much as I like having a rock in my shoe. And I'm terrified to touch my retirement savings. I definitely wouldn't touch retirement savings or get into debt for something like a laptop or car - it would have to be a true emergency like job loss or a huge medical bill. But with cash on hand I don't have those negative associations so I feel great about spending it.

I tried keeping an emergency at other banks and in CDs in the past - it didn't help, I still spent it.

Suppose hypothetically I were to put $10K on a credit card for a life-and-death emergency. If I snowball it (lowering 401K contributions to 6% temporarily so I still get the company match, stopping my other retirement savings temporarily, and stopping helping my family temporarily) I could pay that off in 4 months and then go back to business as usual. The total amount of interest looks small to me - like treating a friend to a dinner at my favorite restaurant, something I do anyway in a typical month. I have to weigh that small amount against the temptation to spend $10K when I have it on hand - and to me it feels like that temptation is a much bigger risk.

The other factor in the mix is job security; the company I work for is extremely stable, I love my job and they love me, and my supervisor repeatedly tells me that the work I do is worth 10 times what they pay me. The possibility of getting laid off is extremely slim.

I feel very, very nervous having more than about 1 month of expenses sitting around in cash. Anything more than that I am sorely tempted to spend, and it starts to affect the spending threshold and timing of my larger purchases. Please let me know what you think ... is there anything I'm missing?

[dczech09]

You need to put emergency savings money into a bank account or money market account that is not linked to your regular banking account(s). Once this has been done, forget you have it there, unless of course a real emergency arises. Part of being financial savy is having discipline.

You mentioned utilizing a credit card to pay for expenses in the time of an emergency, then spending 4 months to payoff, and not save for retirement in that period. What would happen if you became unemployed? I know its not something fun to think about, but be real for a second. If you become unemployed suddenly, a credit card is absolutely the LAST THING that you neeed.

Save the money, set it aside, and realize it is there for a reason. I myself have gone about three weeks without pay because of a job transition; it sucks. I did not have to use my emergency fund luckily, but I had A LOT of piece of mind knowing it was there.

[dczech09]

I'll also mention that there are people out there who thought they have very good job security, only to get layed off. Think of setting aside money for emergencies as paying a premium on "financial disaster insurance" or "rainy day insurance."

[nmboone]

This is really terrible to think about, but what if something happened to your supervisor and another supervisor came along that hated you? Then you were laid off for about 6 to 8 months. An emergency fund would reeeeaally come in handy.

[jaine]

These are all good points, but ... I'm playing out in my mind how I would respond to the 6- to 8-month layoff situation and it just doesn't seem that terrible to me.

In the case of a layoff I would go to the Roth IRA instead of the credit card (because I can't snowball debt while I'm unemployed). 8 months of essential living expenses is about $16,000. Suppose I take that amount from my Roth IRA. Then I would have $64,000 saved for retirement at age 28 instead of $80,000. Is that really so terrible? I wouldn't have to pay a penalty on it because I've contributed much more than $16,000 to the Roth IRA so far and the penalty is only if you withdraw the earnings.

In the case of an emergency that happens while I'm still employed with no sight of layoffs in the future, I would probably lean towards the credit card route. Suppose in 2011 I have a car accident and a $10,000 medical bill. I spend 4 months of the year snowballing $10K in debt (stop helping my family, reduce 401k to 6% so I still get the full company match, and temporarily stop IRA contributions). And the other 8 months of the year, back to business as usual saving for retirement. In that hypothetical year I would be adding more than $16,000 to my retirement savings (not including the company match). Is that really so terrible?

I'm not trying to be argumentative. I'm just trying to see if I missed anything. These hypothetical scenarios just don't look so terrible to me.

[disneysteve]

Honestly, your situation probably calls for a smaller than normal EF. You have 24% of income going to retirement savings. If some costly emergency arose, you could temporarily reduce your retirement savings to pay for the emergency. That wouldn't be so terrible.

I totally, 100%, unequivocally oppose withdrawing money from or borrowing from a retirement plan for any reason other than retirement, so I wouldn't support sucking out your Roth contributions for anything but a dire, life-threatening situation, but I wouldn't have a problem with reducing 401k contributions for a few months.

Why don't you start with just keeping a small EF, not big enough to go out and splurge on something major like a car but enough to cover a typical car or home repair. I think Dave Ramsey's $1,000 figure is a good one. If you are able to leave that untouched, try upping it to $2,000, which would be 1 month of expenses for you.

ETA: The one problem with this is if the emergency is a job loss. Then you're screwed. You'd be forced to stop the retirement savings anyway since you'd have no income and $1,000 wouldn't last long - about 2 weeks in your case.

[maat55]

Once you convince yourself that you have to have it, it will be easier to keep. If I touch my EF I have to replace it with car fund money.

Not slowing down my car fund building is very important, so I do not want to touch my EF. I have convinced myself that my EF is sacred.

[Fizgig]

I'd suggest that you start two new savings funds - one long term (emergency fund), and one short term. The short term account is fine to raid for a laptop, vacation, cute pair of boots, etc. The EF is only for when the sky is falling. Maybe having an account that you're free to use will keep your hands out of the cookie jar.

[MonkeyMama]

Once you convince yourself that you have to have it, it will be easier to keep.

Agreed. I think you are seriously under-estimating the threat of job loss, disability, etc., etc. I think if you understood on a deeper level, you would have no problem keeping an emergency fund. To me, I am debt adverse, and that is what makes me big on an emergency fund and cash savings.

I think you already asked about the ROTH/emergency thing. It's fine if you are putting plenty into retirement otherwise, and keeping the emergency portion in something safe like cash. It sounds like in your case, you will save more money in the long run. Sometimes you just have to do things a little different for your personality.

That said, I would still work on building up a mini emergency fund outside of your retirement funds. You need to work on your disclipine. The ROTH is a relatively new retirement vehicle and won't be around forever. Some day your only choice may be cold hard cash in a bank account.

[TBH]

I have to play these games with myself too. My spouse doesn't understand it. Before we combined our money, he would let thousands of dollars build up in his checking account and he felt no temptation to spend it. I wanted my checking account balance to be zero at the end of the month, with all extra money squirreled away in savings accounts earmarked for a specific purpose. If I have extra money in my checking account, I spend it.

I also have a problem spending the money from my EF. And unlike the OP, I have experienced how essential a good EF is. I have a medical condition that has made me unable to work for several months twice in the past 3 years. I know, I know, I should have had disability insurance. But it's too late for that now.

My solution is imperfect, but it seems to be working okay. I use the same fun for EF savings and for big incidental expenses, like annual insurance premiums, major house or car repairs, vacations, etc. But I have a certain number that I don't let the fund get below. (In my case, it's $30K, which is about 6 months' worth of living expenses if we lost all 3 sources of income). If the balance drops too low, I suspend all big discretionary purchases like plane tickets, etc until it's back up where it needs to be.

[knsfinancial]

2 Savings Accounts Seems Best for You

I'd suggest that you start two new savings funds - one long term (emergency fund), and one short term. The short term account is fine to raid for a laptop, vacation, cute pair of boots, etc. The EF is only for when the sky is falling. Maybe having an account that you're free to use will keep your hands out of the cookie jar.

I think this is the best approach in your case. One account for spending, and the other for emergencies.

Put the "real" emergency savings in an online account that isn't linked to any other account so it will take a few days for you to get the $ anyway (in case you get the urge to buy something the other account can't fund). This way your retirement accounts are able to grow without hindrance, and you can avoid paying ANY credit card interest (no matter how small).

Also, I was thinking about what you said regarding your retirement savings - "having 64k instead of 80k isn't all that bad". The problem with this is that it fails to consider the fact that the $ is no longer compounding on your behalf. Also, consider if you have to withdraw more than the "penalty-free" amount that you are allowed to withdraw (from your Roth accounts) - in case 16k isn't enough.

Don't forget, more than one "emergency" can pop up at once!

[jaine]

Thank you for the tips everyone!

I think I'll start with a 1-month emergency fund in a non-retirement account. That seems like a good compromise. I really want to focus on the retirement savings this year because it lowers my taxes and I need that. If I max out the 401K and SEP-IRA then my taxes are as low as possible. Starting in 2011 I think I can start to save more cash. I definitely want to pay with cash for the next car or laptop.

[maat55]

Thank you for the tips everyone!

I think I'll start with a 1-month emergency fund in a non-retirement account. That seems like a good compromise. I really want to focus on the retirement savings this year because it lowers my taxes and I need that. If I max out the 401K and SEP-IRA then my taxes are as low as possible. Starting in 2011 I think I can start to save more cash. I definitely want to pay with cash for the next car or laptop.

You have to make your financial plan a religion. Saying you want to buy your next car with cash is not good enough, you have to make it a commitment. Whether you do that is up to you, but personal finance is largely mental behavoir.

My wife and I want so bad to go buy a little more car than we can pay cash for, but we will not do it because we do not want to pull the legs out from under our plan. We will get the car we want, with a little patients.

[jaine]

Maat you are preaching to the choir I see that I worded that in a confusing way. What I meant is: Starting in 2011 I won't be eligible to contribute to an SEP-IRA anymore because I'm no longer a contractor, and I'm already contributing the maximum allowed amount to the 401K and Roth IRA, so there's nowhere else to put my savings in 2011 except for in a cash savings account. That's what I meant. Don't worry, it was more than a side thought. There aren't any behavior adjustments needed to get me to a point where I'm saving a lot. I'm already saving a lot ... just prioritizing where I put it so that my taxable income is lower.

[buildmybudget]

Have you considered a cd ladder? Put $1000 into a 6 month cd every month for say, six months, so that after six months you have 1000 available every month that you can simply rollover into a new cd if you don't need it for an emergency. thesimpledollar.com has a good blog on cd ladders.