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June 24, 2009

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I agree the amount in the emergency fund needs to depend on the times but the problem w/that is you don't just save that overnight. However, its hard to say oh we're in a bad economy now have 12 months instead of 6 because that change is not going to happen over night.

I think 6 months is a good baseline and you should be adding to it as you go along. When/if it gets to large you can trim it down in the future which is what my wife and I actually just did. We took a lump sum and threw it into our HELOC. By doing so we obviously reduce the interest we're paying but can always take it back out if our cash fund is depleted (kinda like a backup for our backup). Now I know all about freezing HELOCS and dropping credit lines which is why it is not primary for us.

We are currently in a position that if I lose my job we're ok for 10-12 mos, if she loses her's we're good for 18-24 mo's, and if we both lose our jobs we're good for for 7-8 mos.

That's great that you've got 7 or 8 months worth! 50% of Americans don't even have two paychecks worth.

BTW, I wasn't suggesting anyone save overnight, that's why I provided a few warning signs that let you know when it's time to start saving.

You should of course have as much saved as possible. If by saying you need a greater emergency fund, you mean you should not feel comfortable having 6 months of money saved and then go back to spending 100% of your paycheck and not doing any further saving/investing, then sure, 6 months would have always been walking the edge (besides dooming retirement), and maybe more so now.

As far as whats in your "emergency fund" though, I don't think you want to stretch it to the point that its need for being tapped is extremely remote, b/c that money could have been invested. You do need a money market/savings acct. emergency fund so you're not forced to sell long-term investments (which may be down and may even mean paying a penalty) any time you get a big hospital bill, the roof leaks, or you're between jobs. These may be 'unexpected' emergencies at the time they occur, but these kind of things will likely come up more than once through life. But putting money in there that you only ever have a 5% chance of ever needing is kind of a waste when you could have invested it instead.

I do like having a Roth IRA because I can tap my contributions without a penalty and therefore the risk is just in being forced to cash out an investment when it may be down, in the slight chance I ever have to do this.

Once you approach retirement I think this all becomes a little moot b/c you should probably have a good bit of your "investments" in cash anyway.

@ Strick

Here is the strategy I have employed. Its somewhat of a tiered setup for my emergency fund.

1 month in a interest bearing checking account for immediate access anywhere. (currently w/ING @ .24% )

3 months in interest bearing savings account (currently w/ING @ 1.5%)

3 months in 6-12/mo CDs (currently w/ING @ 3.5%)

This essentially helps maximize interest earned while giving easy access to it. In fact all my money is doing something. Every CC has rewards, every checking account earns interest and/or points. So I try to have my money work for me everywhere possible in some form or fashion.

We've always been savers and our only debt is a small mortgage payment, but separate from our retirement portfolio and college funds for our kids, we only have about 7 months in emergency savings. Assuming at least 6 months unemployment pay (and in my case I have about 3 months of vacation banked that would serve as a severance package) we have enough for about a year.

But we've stepped up our savings rate since last fall and now have the attitude there is no upper limit on the amount we should have saved.

Ditto what rwh said. You can never have enough saved! My "emergency" funds are 6 months in money markets and 12 months additional in multiple CDs laddered so that one matures about every 3 months.

One thing I would like to mention about this article. You talk about warning signs that should cause you to start saving. In reality, you should start saving when times are good. If you do it consistently, you won't have to panic when you start seeing warning signs around you.

One thing you can do is to use direct deposit to your advantage. Most places will allow multiple direct deposit accounts. You could take $100 each paycheck into a savings account, then the rest into your checking and it will add up over time.

I wish I could say I always practice what I preach, but I'm better off than many. It did take some warning signs at my company to start saving. Now, times are better and I have about two months worth of expenses saved up. I also have a rule about bonuses, one third of the net goes to emergency savings, one third goes to debt, and the other third is the bonus I get to spend. I know it's not perfect, but it helps my financial position and I get to have a little fun.

There are a couple of very low volatility, no transaction fee (NTF), mutual funds that offer a better return than short term CDs for investing your emergency money. Both funds have a minimum initial purchase of $2,500 and minimum subsequent purchases of $250 at Fidelity where I keep all of our investments.
SMUAX is a short term municipal bond fund that has had a total return over the last 12 months of 4.8%.
SNGVX is a short term government income fund that has a total return over the last 12 months of 6.64%.
Both funds are rated 5 star by Morningstar. Money market funds are useless because of the extremely low interest that they pay.
Be aware that when you examine the charts of funds that are primarily income funds, most Internet sites that offer charting do not take account of monthly additions of new shares to reflect the monthly income. For a correct chart you need one that is adjusted for all distributions. Without considering the distributions the charts will look more like flat horizontal lines.

Since your emergency money should not be in an IRA or 401K but in a taxable account then SMUAX would be the preferred choice. At Fidelity, if an NTF fund is sold prior to holding it 6 months then a transaction fee of $75 is incurred. Of course, CDs also have a penalty for early redemption.

In my case 'Emergency' does not mean what it does to younger people that are still working, for me it means money that I can get my hands on quickly without having to sell investments such as individual municipal bonds and CDs that I am holding until maturity.

I'm a big supporter of the six month emergency fund concept, and I've got one myself. But it's important to suit things to each individual situation--both higher and lower. As part of my benefits as a senior executive, I get a minimum of six months severance if I'm terminated, and in three more years that goes up to twelve months under our benefits program. If someone has his mortgage paid off, six months might be too much of an emergency fund. On the other hand, when you tell some folks that they need to have six months--or as you do, even more--I worry that it sounds so daunting that they give up. Nine months is better than six months, but six is very good. And three months is better than one month. So start somewhere! I keep my entire emergency fund in an FDIC insured ING savings account, currently earning 1.5%.

Paul,

You should have a contingency plan in case the company finds a 'loophole' where they can terminate you without paying the severance, like an error on an expense report or other mild indiscretion. Sure the odds of that are low but it never hurts to have a backup.

-Mike

Great post!

I am a neophyte in regards to investing and getting my emergency fund up to date. I figure that my monthly expenses are about $2,000 and I have $4,500 in my emergency fund right now. I recently bought a home (rates are so low and the cost of my home was excellent). Since I bought the home, I had a number of additional one time expenses but now I am in the position to start saving as much as possible, which is about $500+ a month. So how much emergency money do I need?
I have a different situation than most people. Although I am single and have no one else to support me if I lose my job, I have a certain amount of job security. I am an assistant professor and in about a year, I will know if I have tenure. I realize that even tenured professors can lose their jobs, but my state has not had to make any serious cuts into our budget. I think job security could change, a. if I don't get tenure, which means then I have one more year after next year to find a job, b. if the economy really bottoms out and the state has to make major cuts all across the board. Since the state is not a major funder of our university, we have not had any serious cuts, except we do not get any raises. My goal after I fully fund my emergency money is to pay off my mortgage. I have no other debts but my mortgage and I have 15% of my salary in an IRA. Once I get tenure, I will have a pension plan that is based on my last 5 years of my highest salary, which I am guessing is approximately 40% of my salary. Once I pay off my mortgage (my guess is in about seven years) I will put more into my retirement fund and have some money for fun. So, how much should I save for my emergency money? And, since I want to pay of my mortgage asap (I have a 4.5% 15 year mortgage), I want to start on that as soon as I am able.
Theresa

Theresa --

I posted your question here:

http://www.freemoneyfinance.com/2010/06/help-a-reader-size-of-emergency-fund.html

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