This is going to be one of those topics that could go very well or could blow right in my face. The reason I say this is because an emergency fund is considered a foundational element of a sound financial plan and for a personal finance blogger to even entertain the idea of not having (or needing) one would be a hard thing to swallow. But before you start disagreeing with me let me set the stage before diving into the title of this post.
What is an emergency fund?
According to Investopedia, an emergency fund is “an account used to set aside funds needed in the event of a personal financial dilemma, such as the loss of a job, a debilitating illness or a major expense. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to draw from high-interest debt options, such as credit cards or unsecured loans”.
I think that’s a pretty good definition; however, I like mine better … it’s money you intentionally and consciously set aside and perhaps forget it even exists. This is money you DO NOT DARE TO TOUCH unless shit hits the fan.
Where should someone park an emergency fund?
If you were thinking a recommendation was coming your way … sorry, not gonna happen. Trent from the simpledollar posted an article on where should someone keep his/her emergency fund and why but it was based on the principles of a healthy emergency fund and not necessarily on suggesting a specific type of account. If you’re still wondering about options let me share what I believe are some of the alternatives out there:
When it comes to my brick and mortar checking/savings accounts I keep the bare minimum to cover expenses I can’t charge to my credit cards (or that charge a ridiculous fee for charging to a CC) such as my mortgage, my car loan and some of our utilities. Aside from that, we don’t have any money sitting on these accounts and neither should you.
Money markets at a brick and mortar bank are horrible in terms of interest rates; however, you can find other options (generally online) that are more competitive but that come with higher minimums.
If you really want to see >2% APY then you’re going to have to commit to both higher minimums and longer terms as is the case of certificates of deposit. Yes, there are no penalty CDs out there but be aware of some that advertise they are but they’re not.
All things being equal, I’d suggest considering an online savings account (OSA). This type of account doesn’t require minimums, their interest rate is competitive, it’s 100% liquid and FDIC secured. If you take a look at my financial money map you’ll see I have several OSAs for different goals. For what is worth I personally recommend Ally bank so feel free to check them out
Do I have an emergency fund?
The short answer is No, I don’t have an emergency fund … why? because I don’t need to … Ok JJ, can you please expand? Well, the only thing I can say is I’m a big believer of allowing your money to work for you.
A lot of folks follow this approach; however, they intentionally keep their emergency funds out of the picture. I neither agree or disagree with that; however, for me to prevent getting more competitive returns would just be plain wrong. I know there’s risk with my strategy but I’m ok with it.
So, what If I lose my job, or need to deal with some major expenditure? How will I handle that or some other event? … the reality is that it always depends but in general these are the options I’ve considered
My strategy for dealing with emergencies
The pie chart below illustrates the split between my buckets for handling emergencies. The percentages are not meant to be indicative of the size, instead they show the relative contribution of working capital I have at my disposal.
- Roth IRA: My wife and I have been maxing out our Roth IRAs for the past couple of years. Withdrawals made before age 59 1/2 are subject to a 10-percent penalty; however, If you withdraw only the amount you contributed (meaning not the earnings your contributions have made on the market) you won’t have to pay income taxes on your withdrawals. I know a lot of people freak out about borrowing from a 401(k) but in this case you’re not even borrowing, you’re essentially using penalty-free dollars from your Roth IRA. Our Roth IRAs are at Vanguard and we keep things simple investing 100% in VTSAX.
- Credit Cards (0% APR): this might not be a popular option but whether you like it or not it is an option. Yes, you need to have a solid credit score to qualify for these type of credit cards and need a heck of a lot of discipline but assuming that’s neither of these are issues then you could be looking at up to 18 months of 0% interest financing. This should give someone enough time and flexibility to either get a new job or find an alternative for getting back on track. We currently have the Blue Cash Preferred Card from American Express that has 0% APR for 12 months.
- Taxable account (40/60) stock/bond: this option goes against what most PF bloggers would recommend, i.e. you should not gamble your emergency fund by investing in the stock market. I actually agree with this statement; however, the word gambling could be taken in so many different directions. From investing in individual stocks to setting an incoherent asset allocation with funds that have absurd fees. Yes, you could screw up big time. So what do I do? well, I’m a big fan of low-cost index investing and using a set it and forget it approach. In my case, I’ve set up an emergency fund at betterment using a 40/60 stock to bond ratio. So far things have gone well (bull market); however, we are supposedly due for a correction. When? who the hell knows. For now, I plan to keep this fund working for me while allowing the asset allocation to play mostly defense with a touch of offense.
- Online Savings Account (5% APY): before you say anything … yes, it’s not a typo. Until recently, I thought 1.25-1.30% APY was the best you could do on online savings accounts but I was dead wrong. As it turns out, there’s a way you can get access to 5% APY. It might not be super straightforward but I’m looking forward to experimenting and seeing if I can park around $10-$15K on this account. Kevin from Financial Panther introduced me to this idea so I will provide an update once things are up and running.
Last but not least, adequate insurance has been critical for supporting my strategy of not having an emergency fund. I have peace of mind knowing that not only are our assets (house, cars, rentals) covered (including umbrella insurance which provides an extra layer of coverage against liabilities) but more importantly, we as a family are very well taken care of with excellent health insurance provided by my employer.
- The purpose of this post is not to recommend having or not having an emergency fund. The decision is ultimately yours.
- Since I don’t have an emergency fund I can’t comment on how big the EF should be; however, I heard something around 3-6 months tends to be the norm.
- There are many options out there that offer advantages to brick and mortar checking and savings accounts; however, do your due diligence and read the fine print.
- If you decide an emergency fund is a critical element of your financial plan, please consider an online savings account such as the one offered by Ally Bank.
- I look forward to reporting on my experiences with a 5% OSA. Stay tuned for a post on my experience using this type of account.
- My strategy might not appeal to all readers and that is 100% fine. We can agree to disagree right?
- Adequate insurance is fundamental for having peace of mind.
I’m always looking for ways to improve our financial plan. This is our current strategy but who knows, next time you read my articles you might see something different. Until then, I’m curious to get your thoughts on emergency funds? do you have one? do you agree/disagree with my strategy? do you do something completely different?