12 Financial Rules Made to be Broken, Rule 2

Here's part two of our series on the 12 financial rules that should (or shouldn't) be broken:

Rule No. 2: Set up an emergency fund to cover three to six months’ worth of your expenses.

Verdict: Thumbs up. You can get by with a smaller stash -- say, enough to pay two or three months’ worth of expenses -- as long as you have a low-interest home-equity line of credit.

The idea is to keep enough cash on hand so that you don’t have to sell stocks or rack up expensive credit card debt if you have an emergency -- but not so much that you lose out on the higher returns you can earn on longer-term investments. Emergency money needs to be safe and accessible, which means keeping it in a bank money-market account or a money-market fund with check-writing privileges.

As you can imagine, I agree with this rule. It's sometimes stated as "three to six months' worth of your salary", but this is really incorrect (though only slightly. The "preferred" rule is as they have it stated above -- "three to six months’ worth of your expenses".

Click here to read Rule 3.

Comments

[S]

I think most people are wrong on just saving up two to three months worth of money just in case something happens. The right way is to save more then you expect, sometimes you may be out of a job for a year or more and don't say never or no it happens so you better believe it and start expecting to save up money for a long time away from work.

[HELOC Blog]

I won't quarrel with the desirability of maintaining a liquid reserve, but blind adherence to this type of "rule" doesn't always make sense. For example:

1. Many people insist on maintaining a reserve even as they make monthly payments on credit card or other debt. If you park your emergency reserve in a liquid money market fund (as recommended), you'll likely never achieve a return that matches the interest you have to pay on the loans. (A low fixed-rate mortgage may be the exception.) Six months expenses for a typical household is in the neighborhood of $25,000. If you have a like amount of debt and there's a 3% spread between interest paid and interest earned, you're paying $750/year for the luxury of keeping the reserve. This is money that might instead be used to beef-up insurance policies to provide protection in the event of an emergency.

2. Along this same line, don't overlook other assets when sizing your emergency reserve. The big financial emergency most people fret over is sudden loss of their job. Many workers have some "bank" of accrued vacation, sick or other leave that is fully or partially payable to them when they leave. In some cases this can equal several months pay. You should find out exactly how much banked time you have and what your employer's policies are in the event of job loss. If you're in the habit of using up all the leave time available to you, even when it can be banked, you may want to reconsider.

3. Also, be knowledgeable of other employer-provided benefits such as long or short-term disability policies, disability retirement benefits, etc. Being educated on these matters can only help you size an emergency reserve correctly.

Perhaps a new emergency rule is in order: If you are a homeowner able to qualify for a HELOC loan, get one while you can - even if you have no intention to use it. Frankly, this may be more important than the "six months reserve" rule. I heard recently from a person who lost their job and was having trouble getting a HELOC. They had done almost everything else right: good credit score, good equity position in their home, and respectable savings/reserves on hand. Still, the temporary lack of a steady paycheck created big problems in qualifying for a HELOC when they most needed it - to help pay for a career transition.

Financial rules, like the 3-6 months emergency reserve, are meant to condense and simplify things. But when it comes to this particluar financial rule, it's worth taking a closer look.

[FMF]

HELOC Blog --

It's hard to have one rule that works all the time in finances, I agree. The answer on whether something works or not for a particular individual in a particular situation usually is "it depends" (on a lot of other factors). But I would say that this one is "generally" correct and that almost everyone, if not everyone, needs a cash reserve of some sort.

FMF

[Mary Anne Martin]

Keep up the great work

Mary Anne Martin
http://www . heloccenters.com

[Mary Anne Martin]

Keep up the great work

Mary Anne Martin
http://www . heloccenters.com