Questioning size/recommendation of Emergency Fund

[Scanner]

Okay, I know the recs are 3 months to 12 months depending on the pundit, Conservative or Liberal.

Of course, if I am questioning it, I guess I would have to lean liberal. I am just wondering. . .a sizable EF is something I have never had. My retirement is about to move into the 6 figures realm (yah! big milestone for me - silver's rally today helped). . .of course, no significant falls withstanding.

Anyway, it kind of goes against my nature to have 36K-50K just sitting around earning .25% (or 1% laddering with CD's) but with my divorce settlement, I am now in a position to have that. I am thinking though of taking 14K of the 36K and putting in a rental property.

I am not sure what I am asking here or asking for. . .I guess a "pep talk" on having a sizable EF. I mean - what are the forum's EF's out there? Do people really have wads of cash just sitting around earning .25%? How do you "other people" live?

[MonkeyMama]

I actually prefer a larger EF. (I don't get the feeling most are really into the bigger EF. I've seen many discussions about how a HELOC will do, or something along those lines, on many financial forums).

For me, I think it stems from always having a large amount of cash. (If you don't have it, you don't know what you are missing?). I have always seen clearly that I have had far more financial and personal flexibility having a large cash cushion. Get laid off, quit a job, have an unexpected expense? Who cares. The money is there to get you through. I've only experienced that peace of mind with cash - would never give it up.

Since having kids, our cash reserves have shrunk a bit, and I have settled with 3-6 months of expenses, but for the long haul, would prefer to have a years worth of income in the bank again. (Less income means more to retirement, instead, for the time being).

The interest rates are terrible at the moment, but that is a short term problem. I have earned up to 6% interest most of the last decade. Most years maybe 4-6%? I wouldn't get so caught up in the short term.

The flip side is we don't borrow for anything (but mortgage). So though the interest sucks at the moment, having cash on hand does keep us from being forced to pay high interest rates on debt.

When the market tanked, I also plowed some cash into the stock market (when stock prices were lower than I'd ever seen them?).

Just some of the pluses I can think of.

[jIM_Ohio]

If you don't own a house, it is possible your expenses went down and you have less risk now relative to when kids lived with you?

EF is about maintaining liquidity in worst case situation... if worst case is different, rethink the whole plan.

[disneysteve]

I see your point Scanner. I would agree that the smaller your overall portfolio, the more important a "full" EF is (however one defines full). As your personal wealth grows, the places you can pull money from if needed tends to grow, too. Yes, you might have to sell some stock or cash in a CD early or make a withdrawal from your Roth but those resources are there. Also, I think as you get your financial ducks in a row, "emergencies" become less common because much of what people call an emergency is really just a symptom of poor planning. Personally, I think the only real emergency that I prepare for is loss of my job. And even then, I wouldn't need 6 months worth of income all at once. I wouldn't really need any emergency funds immediately as we keep enough in our checking account to cover our expenses for a few weeks and we keep enough cash on hand to cover a couple more weeks. Add in the nearly $100,000 combined limits on our credit cards and we could go quite some time before we'd actually need to tap any of our accounts.

All of that said, I do keep emergency funds that almost certainly far exceed any possible need for them. That is actually something that I want to work on in 2011. I'd like to cut back on what is sitting around earning nothing or close to nothing, work on paying off our mortgage over the next 4-5 years and make sure I've got enough on hand to buy a car.

[Scanner]

Well, I know some emergencies to account for:

1. Self-employed health insurance has a limit of $500/year on diagnostic testing. If I got sick, I could certainly give my docs a "pep talk" to not order tests willy-nilly but not be gun-shy too. So between that and dental, I'd like to keep a 90 day CD of $3000/year in case of a dental catastrophe or a diagnostic catastrophe. My copays for the ER are also $250 and outpt. surgery $500.

2. Car repair: $3000 (transmission or something). . .probably add $200/month for a new car into that.

3. Home repair: They estimate 3% of your home value per year. . .of course, some years that's low and then all of sudden, bam. . .you need a new roof or something. So, I'll fund that "sub-account with $400/month to begin with.

I don't know. . . I am glad you see my point, but I also see MM's point in that tehre could be a "perfect storm" one year when all of these things hit. At the same time, sometimes you can make payments at no penalties on bills. . .like the radiology center or dentist or something. I don't like to do that more than 3-5 months but I have done it in the past.

Yeah, then I think about the Roth being available, home equity, etc. . .hard to know what to do. . .I have to tell you all though. . .if I hadn't put away $$$ towards college and retirement before earmarking for an EF, I am not sure I'd have anything for retirement by now. I was the saver in my ex-marriage, long term anyway. . .never that good at short term.

[kork13]

Scanner, I totally agree with you. I had this argument with myself last year, and with the input of everyone on these boards, I came up with the following solution (which I believe in wholeheartedly):
- 1 month's expenses in CASH, regardless of interest rate.
- 2 months' expenses in mid- to long-term bonds/CD's, aiming for improved interest rates.
- Taxable investments as the long-shot backup if needed.
In all, my EF is 3 months' expenses, or about $15k right now (thanks to the wildly expensive COL here in Japan). This excludes, of course, about $50k in taxable investments, which are actually intended for a home purchase down the road.

What I like about this setup is that it provides adequate cash available if something crazy happens, but not so much that alot of money sitting idle. In most cases, the cash account can cover anything. Plus, I'm saving enough elsewhere that I can replenish the entire $5k within 2-3 months if necessary. If the cash can't cover something, or the 'emergency' draws out over an extended period, it's a very simple matter to close CDs, or to sell some investments.

I use a standard savings account for the cash, and $1k I-Bonds for the second part (allows me to only cash out what I need), which gives better returns, are guaranteed by the gov't, and also provide inflation protection. It's true, the I-Bonds can't be sold for the first year, and if redeemed within the first 5 years you lose 3-months' interest. But after that, there's no penalty, and they can remain in place for 30 years (no need to re-open CD's every year or two).
Finally, the investment portion can be in anything you want. Mine is invested in a mixed stock/bond allocation (slightly stock-heavy), from which I can liquidate any amount within 2 business days. Additionally, I do add ~$100/mo to the cash account, but if it goes unused, I transfer the excess semi-annually to the investments.

I love this setup, and expect I'll stick to this for many years to come. It's simple, effective, and sufficiently protects me from any reasonable crisis (short of the world pretty much coming to an end, in which case our savings won't mean much of anything anyways--zombies don't much care for cash, they prefer brains. )

[jpg7n16]

Okay, I know the recs are 3 months to 12 months depending on the pundit, Conservative or Liberal.

Of course, if I am questioning it, I guess I would have to lean liberal. I am just wondering. . .a sizable EF is something I have never had. My retirement is about to move into the 6 figures realm (yah! big milestone for me - silver's rally today helped). . .of course, no significant falls withstanding.

Sorry, but why would your change in income affect your level of EF need?

It is 3-6 months expenses, not income.

Anyway, it kind of goes against my nature to have 36K-50K just sitting around earning .25% (or 1% laddering with CD's) but with my divorce settlement, I am now in a position to have that. I am thinking though of taking 14K of the 36K and putting in a rental property.

I am not sure what I am asking here or asking for. . .I guess a "pep talk" on having a sizable EF. I mean - what are the forum's EF's out there? Do people really have wads of cash just sitting around earning .25%? How do you "other people" live?

I personally have right at 3 months held in cash, and another 7 months or so in a taxable brokerage account. That is mainly held in stocks (PG, BRK-B, WMT), and a high yield bond fund (NHS).

Then I am single, young and have no kids. I don't need a huge buffer, so I'm at the low end of the spectrum. There's no way you would catch me with 6 months in cash.

[Scanner]

Kork,

Thanks for your reply and honestly, if you thought and thought and thought about it, I have so much on my mind right now, I am happy to let someone else do the thinking for me.

The problem with your scenario that I can see with me is I don't really have any place for a non-taxable investment.

I have a Roth IRA and a SEP-IRA both and I really can't ever see maxing them out, along with contributions to 3 529's.

So. . .1 month of cash - doable
2 months of CD's or I-bonds - doable

What to do after that puzzles me - kind of use the Roth contributions as teh "back-up"? HELOC?

The nice thing about my area is rentals are scarce and if I did lose my job, or became ill or disabled, I could rent my place out, little problem and still clear after taxes, insurance, and mortgage. And then move in with the parents (humiliating, but I would do it if I had to I guess).

I don't know. . .I guess probably more than $$, having an Emergency Action Plan vs. it being entirely about $$$ is the best idea.

Probably what happens is when most people have emergencies such as a job loss, they go through those stages - denial, anger, bargaining, depression, and acceptance. If they hang out in any of those stages, that's worse than having 50K laying around in cash. I mean, even if you have 50K as per Suze Orman or Dave Ramsey, the question is. . .should one really just fund a lifestyle that is negative in cash flow or make immediate adjustments when that lifestyle is threatened?

I guess being "reactive" and "flexible" is your best EF.

(my bit o' wisdom for the day)

[maat55]

I keep 10k EF, car fund and building fund in one checking account earning 4.1%.

I keep another 4k in 2 other checking accounts as buffers that earn nothing.

I also keep a few k around the house for just in case the bank is closed.

My car funds and building funds add an extra cushion if necessary, so I do not feel the need for a large EF, due to my expenses are low.

[kork13]

The problem with your scenario that I can see with me is I don't really have any place for a non-taxable investment. (I assume you meant '"taxable" investment'?)

I have a Roth IRA and a SEP-IRA both and I really can't ever see maxing them out, along with contributions to 3 529's.

So. . .1 month of cash - doable
2 months of CD's or I-bonds - doable

What to do after that puzzles me - kind of use the Roth contributions as teh "back-up"? HELOC?

That was just my plan of attack...I would definitely say you should tailor any plan to fit your own needs. And as you said, planning and flexibility are the key. When I built my EF arrangement, I already had a significant amount of taxable investments, so it was a natural fit for me. If your Roth is best for you (understanding that doing so can be playing with fire if you're not very careful/disciplined), I don't see it as a terrible idea. Normally, I'd say 'NO WAY!', except that it is on tap only after exhausting 2 levels of emergency cash before reaching that point.

At the same time, it's very easy to open a taxable investment account with a few basic index funds or whatever that is slowly built up with just a few hundred a month, and doesn't involve any of the hazards entailed with relying on the Roth. If you've already got 4-6 months' expenses saved up, you can use that to jumpstart your taxable investments, set up an automatic $100/mo contribution, and call it good with almost no impact on your Roth/SEP IRA's.

I only meant my EF plan as an idea, not necessarily as the gold-standard. Adjust as needed to fit your needs.

[disneysteve]

At the same time, it's very easy to open a taxable investment account with a few basic index funds or whatever that is slowly built up with just a few hundred a month, and doesn't involve any of the hazards entailed with relying on the Roth.

This is actually how we started our investing life - $50/month into one mutual fund. We later increased it to $100. THen we added another fund with a monthly deposit. We still hold both of those funds though no longer add to them. Now we have one other account, an index fund, that we fund monthly for $400. That is earmarked for retirement but it easily accessible if needed for other purposes. We've never touched it and hope not to for the next 20 years but it is there just in case.