So I have 3 blog entries in January and then *poof* I disappear for the next 6 months. It's a good thing I dont have my exercise regimen tied to the frequency of my blogging, or I would be one large dude by now (and not in a muscular way).
The year has been a busy one, especially financially, but I will save that information for my annual self-introspection entry, due to come out in late December. Given my lack of regularity on this site, that should be the next time you hear from me.
Nonethless, I have an interesting topic for you to debate. Dont worry, you wont hurt my feelings if you disagree with me or each other, as the identification of an individual's emergency fund is different for everyone.
Here's the background: In June, my DW determined that, for a variety of reasons, she needed to resign from her job. She had been after me for years to stop working, and my canned response was always "Only if you can stop spending money." (Not that she is irresponsible in any way, but it was said in jest) Well, due to health and family concerns, we decided it was time to get serious. But she surprised me by coming out with, "I want to see if we can do the Dave Ramsey system." (We have some close friends that have been doing this for a little over a year, and I think she sees their success as something for which to strive.)
Being the numbers guy that I am, I have read most books by the popular finance gurus and have even used techniques from each of them in one form or fashion over the years. I like what the DR system can do for someone that has no concept of their spending habits, or for anyone just trying to get debt free. However, I have never been one to follow a recipe completely (I even put ham in my deviled eggs!), and I prefer to refine any free advice with my own knowledge and common sense. That is to say, I appreciate the intent in the DR philosophy, but will alter it to our situation.
I evaluated our cash situation at the time and determined that we could take care of the first couple "baby steps" right away: $1000 EF + pay off all non-mortgage debt. I had already maxed my 401K contribution so the 4th step is gone too. But what about that 3rd step - 3-6 months' EF?
I think we have covered at least a month's worth of EF through a current initiative. We have been working to stock up a full month's worth of expenses in our primary checking account and should be there soon. The goal is to live on last month's income (Hello YNAB fans!).
But in talking to my accountant, we dont see the sense in holding any more than that in a low interest savings account. Think about it. If you have, say, $25k sitting around "just in case", do you want it making 1% or 10%? That 9% is an awfully expensive insurance policy, and it gets even more so as the years go by, due to compounding.
You could debate that it's not quick to get money out of an investment account. I counter that with a backup plan to my backup plan. I have a $15k personal line of credit that I opened last year in case there were last second overruns on our pool construction project (fortunately, there werent). So for $25 a year, I can keep it open and it is there, acting like a 9% credit card, that is only used in the most dire emergency. There are no transaction fees and it is tied to my bank accounts, so I could have cash almost instantly, if needed. (Then when the investments are liquidated, I would eliminate the debt.)
Remember, we are talking emergency fund here, so none of it will be pretty. It would only be the most emergent situation, one which I hope to never need.
Sound feasible? Debate amongst yourselves. My accountant and I are on the same page, so I am comfortable with our strategy. I just wanted to share for the debate of my readers... both of you.
Next Entry: DR Step 6 - paying off the mortgage? or not?
The Great EF Debate
July 23rd, 2013 at 06:02 pm
July 23rd, 2013 at 08:06 pm 1374609966
One extra cash stream that I rarely think about is the 'set aside' linked to chequing savings a/c that holds sums that will be needed for upcoming expenses like annual insurance premium, international travel plans, home refurbishment upgrades etc.
I know I can cash one of several non retirement investment portfolios in two business days. In these days of negative savings when inflation is negatively impacting buying power I keep adding to either Dividend ETF or inexpensive Index MF.
July 23rd, 2013 at 08:08 pm 1374610128
July 23rd, 2013 at 10:25 pm 1374618306
Remember, in a pinch, you can also use a credit card to buy most goods and services, and then have 30 days or so to move money around before you have to pay a single cent of interest.
July 24th, 2013 at 03:19 am 1374635942
Not only do you have to think of personal emergencies, you have to take into account that sometimes your emergency will coincide with a national or a global emergency. In those situations, cash will always be king, even at .75%. I still would do the 3 month savings with cash (CD, I bond, etc).
July 24th, 2013 at 04:42 am 1374640926
And yea i keep cash as part of my emergency kits and could survive a month or so on that.
I worry more about an event wiping out the possibility of credit cards and debit cards not working for a few days or the economy changing enough to ot be ae to use them. In an emergency i would be working non stop.
July 24th, 2013 at 07:31 am 1374651112
DW has her accounts whence she pays the bills, which adds yet another buffer. I, too, keep a significant amount of cash in the apartment in both US dollars and UAE dirhams. The dirhams are necessary as many places do not take my debit visa card, such as taxis.
I feel I can ride out any short-term absolute emergency with cash on hand or within easy reach, and get money from my mutual funds if need be. Like you, they are not retirement accounts, but merely investment accounts. There will be no withdrawal penaltyl, only the opportunity cost.
July 24th, 2013 at 01:11 pm 1374671494
The purpose of an emergency fund (or cash savings) is not return on investment. The purpose is to protect principal. Making decisions based on temporary market conditions is rather dangerous. (Giving up principal protection for a higher interest rate - DANGER! Just the same as you don't decide where to put your money based on current highest returns. Hopefully you have a well diversified portfolio).
I think there are often two things at play with the "I don't need an EF" mindset (aside from very personal circumstances, because that will always come into play too).
1 - When you are just starting out that efund is going to be a good chunk of your net worth. Further along, you are going to be able to rely more on your investments to cover emergencies. So, I think it's fair enough when you are much further on in the game. But I also think it's important to understand the risks. There is always going to be a time when a cash portion of your portfolio allows you to jump on an opportunity. Keeps you from having to cash out your investments at the low. Allows you to buy investments low, etc. So, just to broaden the view a little bit. It's not so simple that the low interest rate is bad and there is no other reason to keep cash. I find cash to be a great opportunity.
Having this attitude I am used to people totally *Freaking out* about how heavy we are in cash. Look, we have 5% - 10% of our entire net worth in cash. I think we will survive.
2 - The more debt adverse you are; the more cash you need to have. Period. If you are happy to borrow in hard times, then it is what it is. To me, it seems that debt just makes a bad situation worse.
I am shocked that your accountant agrees that the LOC is a good backup plan. I haven't seen *anyone* who thought that was a good idea since 2008 - Baselle points out why. (& yes, this was a very popular strategy in the bubble).