The Emergency Fund has been on my mind for some time now. It’s this classic tool in personal finance that supposedly everyone knows about and should have. After listening to a recent podcast in which the guest said he doesn’t have an Emergency Fund and it’s a waste to have one, I reflected on this concept to really solidify my own strategy.
The main considerations in an Emergency Fund come down to three questions: what is it? where is it? and how much is it?
What is an Emergency Fund?
An emergency fund is the money set aside “just in case.” It’s like personal insurance. So just like I pay for car insurance, health insurance, and homeowner’s insurance, I create myself a personal insurance for everything else that isn’t covered by the actual insurance. The one thing that basic personal finance articles will tell you is to know what is an emergency, in that needing new shoes is not an emergency. I am a long way past knowing that and I’ve been considering whether or not I’ve ever encountered an actual financial emergency in my life. It can be hard to budget and to plan for something you’ve never experienced. I can always budget for energy bill increases in the winter because I know exactly what those look like. However, it is more difficult to plan for a situation I’ve never encountered.
The big names in personal finance – Dave Ramsey and Suze Orman – say your emergency fund should be anywhere from 3 to 8 months worth of expenses. So that makes me think that the emergency fund is for when you lose your job. You’ll need money to cover your cost of living. And there are also the emergencies that could happen even with a job: major car breakdown, unexpected & uncovered home issue, or a medical emergency. I have needed to define these two emergency types for myself in order to clarify what the fund is, where it is, and how much it should be.
I have one time encountered an emergency, according to these two definitions, and it was when my old car needed $900 worth of repairs in the summer before I started working as a full time teacher. I, of course, did not have an emergency fund because I was just graduating from grad school. I had to float the cost with a credit card and it gave me a great deal of anxiety. I worried every day about it. I wondered when I would get paid. I tried to ask teachers who were already working at my school if they remembered when their first check came in. I didn’t want to ask my parents for money; they’d done so much to help me already in my life. I hated feeling that way. It was an expense under a grand and I felt that way. I would never want to have to pay a bigger expense with a credit card.
How much should be in an emergency fund?
Car expenses can sometimes cost several thousands of dollars. While I was saving for my house, I kept $3000 in my original savings account because I figured that would be how much an out of the blue car emergency would cost me. Now, I had a brand new car, but I still felt this was a good fund for me. If you are just starting out, you want to build up at least $1000 cushion for yourself, then build it up more. Technically, until I bought my house, my downpayment fund was an emergency fund as well. I tend to think in terms of actual emergency fund and back up emergency fund. It’s sort of meta-emergency.
Now that I have purchased my home, my monthly expenses are pretty much set in stone, so long as I consider inflation as part of it. My mortgage monthly payment will stay the same unless I change my homeowner’s policy or my property taxes change. I calculated my monthly necessary expenses (so excluding gym membership, Netflix, and fun) and it’s about $1700. I don’t include costs to improve my home, since those activities can be halted in the face of an emergency. I can’t exactly go without heat in a snow-belt winter. Three months worth of expenses are about $5100 so I have been trying to build up a new fund worth this much. I don’t feel a ton of pressure to make it 6 or 8 months worth because of my profession. If a teacher is going to lose their job, they tend to be notified in April and have time to look for the following school year. As a math teacher, my job is more in demand that some other departments. It might be blind faith, but I am confident that I’ll get a job if I were to lose this one. I potentially could lose my job but go no pay periods without getting a check because I have my salary split to pay out all year instead of the 10 school year months.
Since I have health insurance with a $0 deductible, I do not need to account for a medical emergency. I only have home and car issues to worry about while working. Determine what potential situations you could encounter and calculate accordingly.
Where is my emergency fund?
Currently, I have one month’s cash in my high yield savings account. I contribute $150 automatically from every pay check to it. It earns 1.5% interest and is FDIC insured. However, I have other money. I have a fund that is for housing expenses. I am trying to be very conservative in spending that down, so it acts as a buffer. I also have a Roth IRA. Any contributions you make to a Roth IRA, you can take back penalty-free since you have already paid the tax on it. I also have my taxable brokerage account that I have no particular goal for at the moment. Just like before when the down payment fund acted as a back-up fund, so does the house expense fund, the Roth IRA, and the brokerage account.
I never want to actually use my Roth IRA, but if I absolutely had to, I would. I would take that money out before charging something to a high interest credit card. My Roth IRA, my house fund, my brokerage account and my actual emergency fund would all be used for the unexpected costs: car, house, or some-unknown-category emergencies. I have another fund that I am building up that would cover the monthly costs if I lost my job. This fund is my 457.
The Magic of the 457 Plan
Remember that state employees – teachers, firefighters, police, and others – have access to a 457 account, called “deferred compensation.” Deferred compensation is very similar to a 401(k) in that you lower your taxable income by contributing, you can invest it in funds available through your employer, and it helps you save for retirement. However, it is unique in that you don’t have to wait until you are 59.5 to be able to use the funds. You only have to “separate from service” to your employer. So that second kind of emergency – job loss – could be covered by the funds in a 457. It doesn’t matter if you retire, quit, or are fired; as soon as you don’t work for your employer anymore, you can spend the money in your 457. I contribute $100 every pay check to the 457. I am lowering my taxable income by doing this and building up a job-loss emergency fund.
Totaling my emergency fund
I think of my high yield savings and my 457 together as my emergency funds. I have $1953 in my high yield account and plan to build that up to $5100 for the three month’s worth of expenses. With $300 a month going toward this account, it will take 10.5 more months to accomplish this, excepting any windfalls of income. In my 457, I have $600 in it, since I very recently opened this account. Once I have my 3 months cash in my high yield savings, I will decrease the after tax contributions to my high yield savings and increase my pre-tax contributions to the 457. The other accounts have other goals for them, so I don’t like to think of them as “oh, I’ll spend those when I need to.” I exclude them when I calculate for my emergency funds. They’re just back ups as I get my footing in the next phase of my life. It is amazing the peace of mind that comes with having this money there as a “just in case.” As it grows more, I feel more comfortable. I feel safe spending money when I have an emergency fund. I don’t feel a pit of anxiety when I think about something happening to my car on a trip home because I know I can cover it if I have to.