My Daily Dollars

It’s hard to believe that we’re finally at the financial stage where we can decide how much to put in an emergency fund. All through my 20s, the idea of an emergency fund seemed rather preposterous. Basically, I used debt to cover emergencies: my credit cards and student loans kicked in for car repairs and other minor emergencies. I often tossed aside financial advice books because who on earth could save six months’ income?

Ah, the wisdom that has come in my thirties. Seriously, it is rather exciting that we can save over $1,100 a month on top of my retirement contribution. You may be saying, geez, there’s no way I could save that. What’s amazing is how quickly that cushion could disappear. If we added in a car payment, higher insurance, a little more to the food budget, and a few more “fun” purchases each month, that cushion would all but disappear. Now that I’ve carved out that much extra money in our budget, I want to keep it going toward savings!

What’s an emergency fund for?
Before deciding how much our goal should be, I wanted to think through what situations would actually require a savings cushion. Zen Habits offers some good reasons for a fund:

Smooth out your budget. If unexpected things come up, you don’t have to continually re-factor your budget to pay for these things. With an emergency fund, it makes budgeting much easier.
Prevent late fees. If you are living paycheck-to-paycheck, you will come up with times when you have to pay a bill late, or overdraw your bank account. With an emergency cushion, you avoid these financial hits.
Get ahead. If you can get a month ahead, your financial stress will drop way down. Instead of always playing catch-up, you can pay your bills ahead of time and sit back and relax.

I also liked Phillip Brewer’s rationale on Wise Bread:  “An emergency fund can also be used to take advantage of opportunities, both big (a business deal you’ve been trying to close for weeks is suddenly available–but only if you show up with a cashier’s check by 5:00 PM) and small (a chance to stock up on tomato paste at 50% off). “  Neither author mentions the traditional reason: in case you lose your job.  Of course, that’s the reason most people think to have one, but I like rationalizing it from the positive rather than from fear.  Realistically, my husband is self-employed and unlikely to suddenly lose his practice.  While my job is more vulnerable, it’s also a smaller chunk of our annual income.  Yes, there may be times when work slows down or one of us has a serious illness, and we need to draw on the emergency fund, but it’s hard to imagine a point where we suddenly have zero income coming in.

How much to put in the emergency fund?
Typical wisdom says three to six month’s of living expenses.  Suze Orman suggests eight months of savings in her 2003 book, The Laws of Money, The Lessons of Life.  This article from CNN/Money urges a year’s expenses in tough times.  Certainly, these seem like uncertain economic times.   However, for us, the maximum of that formula could be over $40,000!  Is it realistic that we’d have a situation where we need that much cash at once? 

Think of the emergency fund as the first last resort.

Socking away $40,000 in a relatively low-yield investment like a savings account doesn’t make a lot of sense to me.  Once I save up an emergency fund, we’ve got other savings goals to get to, including a car and mutual funds.  At the rate I’m going, it will take twenty-eight months to save $40,000.  I don’t think my current car will let me wait another ten to twelve months to save up for a new one, for a total of almost three years.

I think every situation is unique, so it isn’t wise to blindly follow the herd.  We’ve got a relatively diversified stream of incomes and jobs in fields that are fairly recession-proof.  I can see needing money in an accident or if someone gets sick, but I think we can access some long-term investments that we have in any type of chronic situation.  Therefore, I want the emergency fund to be the quick cash we might need, but nothing more.  The husband has also has a savings account and keeps a cash reserve for his business, so we’ve decided that he’ll save $10,000, and my goal will be $6,000.  Together, that would cover three to four months of bare-bone living expenses.  If anything more serious happens, we’d have to tap some investments or credit.

Once I have the emergency fund in place, I think we’ll start saving for a new car for me.  Then, we’ll finally get to more investments, hopefully in the next eighteen months to two years.  I’m setting up a chart to track our progress.  I’ve got $600 in my ING account right now as an emergency fund.  Let’s see how quickly I can get to $6,000!

How about you?  Do you have an emergency fund?  What’s your target?