Hi. I’m Kevin McKee from Thousandaire.com.
Last November, Daniel wrote about How to Use Personal Finance to Make Friends, which in his case was to steal money from a corporation and give it to a stranger in the store. Daniel is a great writer and a good guy, but we don’t always see eye-to-eye on things. This week, we have a little disagreement on Emergency Funds.
Daniel posted at my site why he thinks Investments and Credit Cards Are Not an Emergency Fund. I say having three-to-six months income sitting around in a 0% or low interest savings account is a big, fat waste of money.
I do truly believe it is essential to have enough money to live for three to six months if you lose your income or have a huge unexpected bill. You don’t want to let one incident ruin months or even years of financial planning and execution. So why don’t I recommend Daniel’s boring emergency fund?
Here is my three step process to covering your financial rear-end without a dedicated emergency fund.
- Have enough money in your checking account and liquid investments to cover yourself for 3-6 months (be willing to sell investments, even at a loss, in case of an emergency, or use a credit card or loan if necessary) and use those accounts as your emergency fund if necessary.
- Be a rock star at work and make yourself indispensable and always keep your resume updated in case you find yourself looking for work.
- Insure yourself against catastrophic situations that could ruin your finances,
My method is a bit more risky than keeping your emergency fund in cash, but with that risk comes the opportunity to substantially increase your net worth via the return on your investments. Why would anyone keep money in an account that returns 0-2% interest when it could be invested in the stock market where the average return is about 8%? The difference between 1% and 8% on a $10,000 balance is $700!
Sure, I could potentially lose money in the stock market. I could have bought at the top of the market in 2007 and sold at the bottom in 2008 and lost 50%. But I also could have bought at the bottom and sold this week and been up 90%. The fact is over a long period of time the stock market has always historically gone up. If you expect that to continue, then I recommend getting involved. Plus, if you do steps two and three correctly, the goal is that you would never even have to tap into this money if you did have an “emergency”.
The real keys to this plan are not losing your job or finding a new one quickly and insuring yourself against unexpected emergencies.
If you work your tail off and make yourself a valuable asset to your company, then you should have no trouble keeping your job or finding a new one if you find yourself unemployed. The most important part of this step is to be honest with yourself about your skills and performance. If you hate your job and just do the bare minimum of what your boss asks of you, then you better not believe you are indispensable. There’s no sense in adding the risk of a negative return on your investment if you are already at risk of losing your job and struggling to find a new one.
Finally, you most likely never have an outrageous unexpected bill if you have insurance to cover any catastrophic financial situations (medical, short and long term disability, auto, home owners or renters). If you have all the appropriate insurance, then keep enough to pay your deductible and invest the rest. I’d also recommend not touching very expensive, breakable stuff that isn’t yours.
By ensuring you are employed and that you don’t have to pay for catastrophic expenses, you dramatically reduce the need for an emergency fund and free up that money to invest at a higher return. Then if all else fails and you do need money, there is nothing stopping you from selling those investments and using that cash. If you’re still short on money at this point, then unless you lost a lot of money on your investments, you would have been out of Daniel’s boring emergency fund as well. At this point you can try to take out a loan or put expenses on a credit card.
Don’t waste your money on a boring, low interest emergency fund. If you aren’t putting your money to work for you, then you’re always going to be working for your money.
If you’re an exciting risk-taker and think I have the right idea, post a comment here and let me know. If you’re one of those lame savings account people, I encourage you to go to Daniel’s article and post a comment supporting his side over there. We’ll tally up the comments at the end of the week and see who wins. Daniel won the first debate (I think it was unanimous) so help me even up the score!
I’m in agreement with Kevin. Too much emphasis has been placed on having a ridiculous amount of cash reserves around, preparing for some future financial tragedy.
It makes more sense to think of how many times in your life you had to access emergency funds and prepare accordingly. For me it has been twice (I’m 42) and in both cases I bounced back with less than $15k.
Stop waiting for tragedy. 1) Get your money working for you. 2) Make better choices so emergencies are less likely to happen.
@Leigh, Finally, someone with some sense! People are so scared of tragedy, but I think they’d realize it’s not nearly as bad as they thought it would be if it happened.
Thanks for the input!
I love that we all think we can predict the future by throwing it into the stock market and not having any cash reserves around.
I also know, speaking as a freelancer my viewpoint is very different (no contracts = no money), but I can tell you that other employees thought the same thing — that their credit cards and lines of credit are their backup plans.
Where are they now?
About to declare bankruptcy, can’t feed their kids, about to lose the house (and just walk away), moving into a shelter and trying to make ends meet otherwise.
These are not “ooo special medical emergency” people, or people who suffered “rare” events like a sudden disease they just found and can’t pay for.
These are normal people covered under universal healthcare, who had runs of bad luck and now simply can’t find a job, ANY JOB (yes even “lowly” minimum wage jobs) in the market. I can count at least 10 couples who have said this to me in confidence, in the past 3 months, in ONE CITY. Let alone the country.
I think of that “lost earnings” as an insurance against real-life things that happen.
Even the earnings are not guaranteed seeing as the stock market a rich man’s lottery.
It is also very easy to say: you’re all idiots for having savings accounts and cash reserves, but just wait until it happens to you, like it happened to a couple who thought they had secure jobs and a secure future. Now they’re in debt by the tens of thousands, having relied on their line of credit as their emergency fund, and contemplating suicide.
Do what you want, ultimately personal finance is just that ===> personal.
But I am going to sleep a whole lot better at night knowing I have cash reserves to handle anything that comes up, rather than risking it all on the stock market just to make a couple hundred bucks extra in a year.
@FB @ FabulouslyBroke.com, freelancers always have to have a bigger cushion and for them, a ‘soft’ emergency fund as Kevin suggests is doubly bad. I commented on Kevin’s site that it’s difficult to predict when something bad will happen, and for most of us hopefully it never will, but we’re planning for the unnexpected, so keeping your job sounds great, but if something were to happen, we shouldn’t rely on risky investments.
Look at 2008/2009. How many people lost their jobs at the same time the market was tanking? That’s a TERRIBLE combination.
@FB @ FabulouslyBroke.com, If those people are tens of thousands of dollars in debt, I doubt “where they put their efund” made much of a difference. The only way they lose 50% of their efund is if they invested in something that went completely bankrupt or they put an efund of greater than $20,000 in the market at the very peak and sold at the very bottom (which would lose about 50%).
Those people were screwed either way. You can’t blame the efund investments for their situation.
@Kevin McKee,
Sorry Kevin, your mentioning of using credit cards and/or loans is simply the most ridiculous thing I have ever heard to use as part or whole for EF. Only an idiot would take out debt when they have no cash. You can debate your idea all you want, but it is not sound. You like to gamble your EF and find nothing wrong with going into debt in an emergency. Sorry younget a big fat score of zero from me.
By the way, it is not lost on me that you said to save 3-6 months in an EF.
These people thought that 3-6 months was enough, but then their car broke down and ate their entire savings. They were left with $0, and started the first month of unemployment with a line of credit.
It is not just for living expenses. It’s also for other emergencies that happen, especially if you have a family to feed and bills to pay.
I posted my support for Daniel and now I need to join the debate here too! Saying you’ll keep your job is not a substitute for an e-fund! The whole point is that you don’t plan on using it (and no one plans on losing their job) but you might have to. Yes, it’s painful to see money just sitting there not in use and not growing to increase the excitement of a greater personal net worth (and greater self worth?) but emergency situations are stressful enough, I prefer the option of having cash on hand to deal with them instead of digging through investments and completely draining the pot.
@Emjaye, if you invest properly, you won’t have to completely drain the pot because you’ll have more money in your investment account than you would have had in your savings account. :)
@Emjaye,
Agreed. Kevin doesnt know the difference between an EF and investing wealth (retirement). These are two separate funds, one is for emergency, the other is for investing. He seems to put everything together and therefore doesn’t really indedstand what an EF is. Especially when he sees o problem with using CC and/or debt as part or whole of your EF. Let Kevin keep gambling, because he has no common sense to talk to about this subject.
As to Step #1 in your post: There is no such thing as a financial emergency so there is no need for an “emergency” fund. Huge health care expenses, even by those who have some form of coverage, are the primary factor behind a considerable number of personal bankruptcies, but that speaks to the short-comings of the coverage. So, I completely agree with Step #3 in your post.
If you don’t have health insurance with a catastrophic limit, then there is hardly an “emergency” fund that will suffice in a worst-case scenario. All other expenses can be planned for and should be accounted for in your monthly budget.
As to your Step#2: Being good at your job is one way to protect yourself from job loss but, really, what you want to protect yourself from is loss of INCOME–the distinction is important to understand.
As long as you are dependent on a single income stream for your financial viability, you are at risk and being good at your job has not proven to be fool-proof.
Instead, you should look for INCOME DIVERSIFICATION–multiple streams of income. It is the same reason that a business seeks different product lines. Ideally, 100% of your income should not come from a single source; 10% of total income from ten individual streams of income would be representative of a more preferable model of income diversification, for the sake of example. In that situation, the loss of any one stream would not be significant.
Income on savings and investments can be considered individual income streams and can help with achieving income diversification but the two streams are different. Income from investments is dependent on the risk of the investment, itself. Income from principal and return guaranteed savings held in long-term Federal government bonds and CD ladders, for example, can be counted on to produce a known return.
No one needs unlimited income from their savings and investments, only enough to meet their cost of living. When you achieve that, you are financially independent. One cannot PRUDENTLY declare FI, however, when their status as such is dependent on investment where the principal is at risk and the return not guaranteed.
If your goal is to work for a living until the typical age of retirement, when you are younger, you can afford more risk because you have more time to recover from market downturns. But the weighting of risk in your portfolio is a window that is closing.
If, instead, your goal is to achieve financial independence as early as possible, then it is more prudent to do so with principal and return both guaranteed. I have never invested in the stock market and I achieved financial independence. It took me fifteen years but it’s the real deal. And I do not need to put my principal at risk because I do not need to chase the possibility of higher returns.
@tmgbooks.com, That sounds like a great plan that has worked for you. Income diversification is a fantastic way to reduce the need for an emergency fund. And yes, health insurance with a maximum out of pocket expense is essential.
It sounds like you agree with my theory in principle (that you don’t need to hold an emergency fund in cash) if you follow steps 1-3, but then you don’t need an efund. However, it sounds like all your money is in cash or other lower returning investments.
Anyway, I will disagree on one point. I think if you want to achieve financial independence as early as possible, it is essential to invest in the stock market. That’s one of the best ways to increase your net worth substantially. If you aren’t investing aggressively, then it will take longer to have enough money to retire.
@Kevin McKee:
I agree that an e-fund is unnecessary although maybe for different reasons than you. For example, is your car breaking-down an emergency? I think not; I think you can reasonably assume that your car will eventually breakdown or need repairs sooner or later.
Instead of an emergency fund, I have a reserve account that I fund monthly. When I need repairs or new tires (etc.), the money is there, the historical annual cost of vehicle maintenance prorated on a monthly basis in my monthly budget.
Another benefit of doing it like that is that my monthly budget also reflects my true monthly expenses. People often give up on budgets because they do not account for all their actual monthly expenses. But what they say when that happens is, “budgets don’t work!” It’s not the budget that ain’t working…
As to the third point in your response: We are not in disagreement as to the benefit of higher risk asset classes in building net worth sooner. Except that, instead of investing in the stock market, I invested in real estate. In two cases I had returns approaching 40%. And I netted almost $150,000 over a five year period.
And, right now, I have a rental with a net ROI of almost nine percent. So, I am still in a higher-risk asset class but that is money I can afford to lose and goes straight to savings; in other words, I don’t count on it to pay the bills.
Two points: The money that confers my status as financially independent is held in principal and return guaranteed accounts. So, I agree that assuming some risk can help get you to FI sooner, just not on the investment vehicle–but to each his/her own in that regard based on what you are comfortable with.
My real estate investment is one stream of income, my publishing business another, the ROI on my guaranteed accounts another, and my speaking and coaching two more and all are independent of each other. But, believe me, it took me a long time to get all the pieces in place!
@tmgbooks.com, Congratulations on diversifying your financial life so well! While you are right that it will take a long time to get those pieces in place, I think you are living a great example of true financial independence!
@tmgbooks.com, Way to many holes there. Number one reason why people go into bankruptcy is not medical bills, it is loss of job, primary income, you know, that income that is needed to create the other 9 streams of income you speak of in your post. Since nobody can work 10 jobs, let alone more than 1 professional career, we the wiser folk who use the proven system of building an EF, then building wealth, then paying off the house and having no debt at all will continue to flourish. Investing in growth mutual funds, paying cash for real estate to rent are solid investment options. Borrowing money for any investment is risky and only for fools and idiots. If your net worth is not equal to or greater than $1M, please don’t share your advice.
@Bruc, If anything, we care more about the people who have a lower net worth! When you’ve got over $1M, an emergency fund is less necessary because it can be covered by a lower percentage of your investments. If you need $10,000 for something, it’s not as big of a deal if you’ve got a higher net worth.
@Bruc, you write: “Number one reason why people go into bankruptcy is not medical bills, it is loss of job, primary income…”
Actually, according to just one well-known and highly respected expert source, Dr. Sanjay Gupta of CNN, the leading cause of personal bankruptcies is, in fact, unpaid medical bills and, again, that is just one source, there are many, many more, leading cause of bankruptcy, for a few hundred thousand more.
And as to my point that a total income comprised of ten individual streams of income would put one in a more financially viable position than a single source of income, it was just that – me making a point; that point being (just to make it as clear as possible for you) that the more sources of income, the better, and the lower the percentage of total income any single source is, the better as well.
Have you ever heard the common investment wisdom that states that you should never have all your eggs in one basket? Well, what that speaks to is the wisdom of diversification as an investment strategy but it is just as wise a strategy when applied to income – diversify!
Being dependent on a single stream of income, from, say, your job alone is a risky proposition. And as soon as you add a second stream (and third and so on) the better and the more secure you will be, financially.
You write, “you know, that income that is needed to create the other 9 streams of income you speak of in your post. Since nobody can work 10 jobs, let alone more than 1 professional career!
Uh, right now I work five and each produces an individual and independent source of income. And I supported my way through seven years of college always working several jobs, as well, and always in addition to a full-time job.
The fact is, working only one job is not a luxury most people can afford, or most families, either, as evidenced by the increasing number of two-earner households; and neither is it a risk most individuals and, certainly, most families should accept willingly.
And although you imply that one’s net worth is somehow a gauge of financial acumen or status, it is not. For example, let’s say you have a total net worth of $1,000,010 and no outstanding debt but that $1,000, 000 of your total net worth is equity in your primary residence. According to your reply, then, that alone would somehow make you qualified to give financial advice. But what if you inherited the house and you only earn $16,000 a year working at McDonald’s? Would you still be as eager to hear what that person has to say about money?
The ideal financial situation is total financial independence. And, yes, I am financially independent.
And no experienced investor will pay cash for real estate as it lowers the ROI. There is risk in leverage but it can be managed to a negligible level. My risk in the investment real estate portion of my portfolio is zero because I am financially independent NOT counting the income it produces.
What you write in regards to real estate (paying cash for real estate to rent are solid investment options) is contrary to the financial strategy that has created innumerable real estate millionaires. Your statement to the contrary speaks volumes.
Finally, if you read my post, I never argue that having funds in reserve is a bad idea, just that referring to those funds as an ’emergency’ fund or even thinking of them that way is not the most sound approach to handling the kind of expenses most people think would require the need for an ’emergency’ fund.
So maybe you should read my initial comment to the original post again and, if you don’t understand something I write, ask a question: that would be the more considered and appropriate first response.
@tmgbooks.com, You write “And no experienced investor will pay cash for real estate as it lowers the ROI. There is risk in leverage but it can be managed to a negligible level. My risk in the investment real estate portion of my portfolio is zero because I am financially independent NOT counting the income it produces.”
Interesting how paying cash for a house lowers the ROI? How did your 7 years of college come to that mathematical result? I wont bother to pick apart other areas of your reply as this alone says it all to me. Let’s see, I pay cash for a 2nd and 3rd house, and you get yourself a loan. The key difference between us in this situation, a time will come when you will need to dump your 2 houses and the market won’t be right and like you mentioned in your original post, you get a loss of your illusionary investment, while me, well let’s make this clear for you, I have the option to hold onto my 2 properties until the market favors me, because I made the wiser choice to save and buy with cash while you overextended yourself with debt you couldn’t afford in the first place.
Like to hear more from you, it is quite comical.
Kevin,
I completely agree with you. In today’s markets if you need cash quickly for an emergency, you can always turn any fund into any cash. Initially, I was saving all my money in my checking account and using Roth IRAs and 401Ks as my saving accounts. I realized that I was losing returns on the money I was saving.
After doing a lot of personal research, I switched my investment options and in the past 12 months I have been keeping about a paycheck and a half in my immediate checking/savings accounts and have everything else invested.
Perhaps my investing habits are a bit extreme but my performance has been astronomical. My overall returns have been close to 200% at this point.
My advice to everyone is to at the very very least open some sort of investment account with their available money and keep some spare cash on hand. As Kevin poignantly commented, ” if you don’t put your money to work for you, you will have to continue working for your money. ”
Dave
@David Isser, 200%, you must be trading options or using some other, very risky investments. That’s awesome! I just got a 91% gain on selling some call options a few days ago. It’s so nice to have that extra money just for doing some research and taking a chance.
@David Isser, Not everyone has the luxury that you do. While 200% is beyond ridiculous and you should be proud (and stick 10% of that in a savings account because it’s chump change to you), what would have happened if you lost all of your original investment? Would you have done? Did you have another fallback plan that made it less risky?
@Daniel, While I agree with you that not everyone has the luxury of investing a majority of their money, I also think that most people become too risk averse and don’t play enough with their money. Long term growth is important but what Kevin was describing was limited to no growth in these saving accounts. It’s very important that people risk a certain portion of their salary in an investment, otherwise their estates are losing value.
In terms of my investments, even when I lose (which I have on certain investments) I redevelop new strategies to continue investing.
@Kevin, I would rather not disclose exactly what I have been doing but it involves selling some call options on stocks “in the money”. So far I have been guaranteeing my investments + more due to the dramatic increases in the values of the options. We can discuss privately if you want some advice.
@David Isser, I don’t need specific details, but I’m right there with you. I typically invest in long term call options that are at or near the money. :)
@David Isser, No doubt that people should take risks with their money and investments. But should people be taking those risks with their funds that are specifically designated for emergency funds?
@Daniel, This is what I was referring to earlier. Emergency funds are basically liquid cash you need immediately if so and so were to happen. I responded back to this by saying most investment opportunities can be liquidated in seconds nowadays due to online services and broker firms. In fact most online brokers will let you link your personal checking and/or savings bank account directly with your investment account to transfer money in or out. Obviously you run the risk of losing some of your profits because of good ‘ol Uncle Sam… but you can always rework the tax purposes later.
Let’s just take a simple example. I make 4000 dollars a month and post taxes, 401k, and health insurance, take home about 2700. 1100 goes to rent, 600 goes to food, gas, car insurance… other expenses.
That leaves me with 1000 dollars a month or 12,000 dollars a year. You are talking about leaving between 3 and 6 thousand dollars aside for an emergency fund. I am arguing that that you should leave about 2000 for spare cash issues… but investing the other 10,000 is a must. If you pick up any investment fund for even 4% a year. that is $400+ that person is losing out on from emergency expenses. Assume he decides to sell the 10,000 investment, he will need to pay ~100 in taxes because of gains. Regardless, he has the 10k plus he has the 300. And this withdrawal can be done within a span of 30 minutes.
Kevin, I agree with you 100%
First off, I am really good at my job, and while that doesn’t guarantee that I won’t be laid off at some point, I doubt it would take me long to find another similar paying job. That may sound a bit arrogant, but it’s true that if you make yourself indispensible to your organization and you network with the right people you will be less likely to lose your job. It does help to have a specialized skill set too. That being said, I feel that those who are self-employed/free lance workers need to have an emergency fund.
In the meantime, if some type of other emergency did happen to me (huge car repair, roof collapse, medical bill, or something that’s not covered by insurance) I would pay for the expense with my credit card which would buy me 30 days to figure out what was best to do next. I could liquidate some of my stocks, or use my line of credit at prime +1% if needed. I usually make $1,000 more than I spend each month, so I know that I could repay the expense quickly.
FFB is right, personal finance IS personal…so this approach works for me but may not be right for someone else. I sleep fine at night though.
@Echo, Sounds like a great plan. You have your bases covered, you can pay for any unexpected expenses, and you can get a new income source if you lose the one you have now. What’s the point of wasting your money in a 0-1% interest account? Congrats on putting that money to work!
Although I am not recommending this, I do not have an emergency fund. I have a line of credit,if I need it at a very low interest rate. One of the benefits of fiscal responsibility. I only pay if I use it. I have an exceptionally secure job (tenured teacher) and so does my wife (RN). My mortgage is lower than the appropriate rent for my home and my mortgage is nearly paid off, no debt and a fairly low key lifestyle. I am exceptionally disciplined and cognizant of all the financial (former CFO) pitfalls. I think my situation may be possibly unique. Should everyone do this, absolutely no!
@krantcents, I love it! People are so scared of that credit card for emergencies because of the high interest rate, but it only affects you if you use it and don’t pay it off right away. Given an “emergency” should be, by definition, a rare occurrence, I think it’s a great way to keep yourself safe if something does happen.
@krantcents, it’s hard to argue with you here, you seem to have a very secure situation, and if your line of credit is big enough and you don’t mind paying interest (or think that the interest you’ve earned by not having it in a savings account is greater than the total interest you’d lose with the line of credit), then good for you!
For most people, follow his example in getting the secure job, but for now, go with the safe bet!
So, having money sitting around in a low-interest emergency fund is a waste of money, but spending it on insurance that you can probably only use in very specific situations isn’t? I believe in insurance, but only on certain things and with high-deductibles in combination with a good emergency fund.
And no matter how indispensable you think you are, things happen. Companies go under or get taken-over by others and chances are that you are not going to know ahead of time because that’s the sort of thing upper management keeps super quiet. I’ve known so many people who were absolutely surprised to lose their jobs because they thought they were indispensable.
Personally, I sleep A LOT better with an emergency fund. My husband and I have seen personally how long a job search can take even when you have a job, great skills and a killer resume and all the right connections. It’s brutal out there. And even if you get the job, there are plenty of costs associated with moving including waiting to sublease or rent your old home. Do you have insurance for that? It can take months to find a renter, let alone sell a house, and what if you can’t find one that will cover the expenses even then?
And as the recent financial mess should have taught people, you cannot depend on credit. Credit can be frozen the moment companies smell trouble. We have EXCELLENT credit — good income, never ever missed a payment, always pay more than minimums — and we still had ours cut. Fortunately, we didn’t need it, but we had friends who ended up having problems covering just the basics because they weren’t prepared financially for job losses or even just raising costs.
An emergency fund isn’t about making you money. It’s about being prepared for the big unknowns — and that’s something that is well worth the money.
I agree with Kevin
I will go ahead and make a couple of comments without agreeing with one person or another because I agree with FB – personal finance is personal. Each person has different risk tolerances (peace of mind is priceless) and different expectations from their financial life.
Of course, the route Kevin is taking is higher risk, but also the highest possible reward. If you can manage to put 10k in your efund and not use it for 10 years, then you would have 25k in stocks, vs. 11k in savings so who cares if it drops 50% (assuming somewhat standard returns for stock market and savings). The route Daniel is taking is safer (and also lower return). However, it takes the worry out of your day and makes you more financially sound than 90% of Americans.
I do want to point out one very important misconception in the financial world. Everybody always discusses stocks vs. savings. Very few realize that there are literally hundreds of different investment vehicles that can be tailored to fit your exact needs. Some safer than savings accounts, some more risky than stocks…and everything in between. Find out which investment is right for you.
For example, if you have insured yourself against most of life’s disasters (point 3) and your biggest concern is losing your job in a recession, consider putting some of your e-fund into Gold (or similar). Gold often performs well in a good economy, and skyrockets in a bad economy. If you are looking for cash flow during an emergency, consider making your efund slightly larger and purchasing some royalty trusts. This way you may be able to cover your emergency without ever touching the original investment. Most importantly, if you want to find out more about these and many other investments, stop by thousandaire.com every Monday for the weekly stock pick and some free insight into these products.
@David Hasselhoff, Nice shameless plug. If you know about the other 100 investments, you’re smarter than me. That’s why I have you around on Mondays to teach me and everyone else!
Kevin – I agree with you 67%. lol No, but seriously, the foundation of an emergency fund is really based on the individual situation. While, I have a low cash emergency fund, I also have no debt, and a reasonable amount of money stashed in accounts that could be liquidated. However, I would not recommend this strategy to people who already have credit card debt, and limited assets. Or people who don’t know how to use credit responsibily. It has been my experience that most people do have debt, and are not using credit responsibly. In these cases, I recommend, 1)paying off debt and 2) building up an efund of 3-6 mons. Another to consider is that a few years back when the economy began to take a turn for the worse, many credit card companies became cautious and began lowering and canceling people’s credit lines. His is another reason, not to rely on credit for an efund.
@Diyah, Great point about lowering credit limits, I hadn’t thought of that. The other thing I really like is that you said to pay off debt first, and then build the efund. It kills me when people make a big efund instead of paying down high interest debt. It’s so much better to pay down the debt, and then if you have an emergency, charge your expenses again. You pay less interest when you pay down the debt, and even if it goes back up, at least you had a period of time when you’re paying less interest.
@Kevin @ Thousandaire.com,
“It kills me when people make a big efund instead of paying down high interest debt. It’s so much better to pay down the debt, and then if you have an emergency, charge your expenses again.”
It depends on the situation, of course, but if you can’t reasonably pay off the debt in a few months and the interest isn’t astronomical, I think it’s wiser to build up a good-sized emergency fund. The reason is that you need the emergency fund not just to cover basic needs, but to also keep paying on the debt. You can often cut your living expenses more and more, but those debt payments usually aren’t going anywhere. And, if you miss them, then you’re really going to be in trouble — especially if you think you’re relying on getting more credit. Again, credit companies smell blood in the water and bye-bye credit line (especially at any reasonable interest). So, be absolutely sure that your EF can cover debt payments as well as basic living expenses and expenses associated with getting a new job and moving.
@Meg, I agree that you need to make sure you can make the minimum payments. However, it’s also important to remember that if you do lose your job you’ll have unemployment insurance to help you pay those bills. It’s riskier to pay down the debt, but it can also save you a ton of money. It is again, a question of risk vs. safety.
@Kevin McKee,
I would not count on unemployment insurance. I had a friend who did not get hers for months. One of the fabulous things about this past economic trouble is that such systems were overwhelmed and many people fell through the cracks. We had to help her out because she was literally about to get kicked out of her apartment while she fought with them. When it came, it was still very low.
Oh, and the reason she was fired was because she got pregnant. She thought she was indispensable but they fired her the day after she found out. She wouldn’t have even told anyone, but she had to go see a doctor that day because she was in pain and didn’t know why. I guess one of her coworkers helped her get to the doctor and then blabbed, not seeing the problem. Was it wrong of them? Sure. Could she has sued? Maybe, though such things are hard to prove. But that wasn’t going to help her in the meantime. Surprises happen.
Last time I checked into unemployment insurance for us, the amount was not enough to depend on for debt payments or living expenses (not “and”, not even “or”). We are getting our debt down, which will make things easier, definitely, but in the meantime it is not worth giving up security for the amount we spend on interest.
I’m going to have to disagree with you Kevin. I was laid off last week with no emergency fund, credit card debt, a car accident a week before, moving in a few weeks, and a wedding in a few months. I worked my butt off at my job and felt that because I was the only one doing my job, I had job security. I was wrong. My resume has always been impressive, and the additional 8 months of job experience made it more so. I’m still looking for work. A “boring emergency fund” could’ve taken care of my car damages, the move (which includes breaking my lease), and this time in limbo. Instead, I’m freelancing my life away to pay bills and take care of these unexpected turns for the worst. So, in conclusion, a “boring emergency fund” (which, by the way, can earn even a little interest in the right savings account) could go a longggg way.
@20 and Engaged, I agree with you that an emergency fund would have helped you, but I bet an investment account would have helped even more (because the market has been going up the last two years and you’d have seen a good return if you had invested). It doesn’t sound like you had an emergency fund in stocks and then lost it all due to unlucky investments; it sounds like you never had money to invest or put in a cash emergency fund to begin with. So while your situation is bad and I’m sorry for you, it really doesn’t prove that a cash emergency fund is better than investing that money, because neither applies in this situation.
Interesting concept. I think the notion of “being a rockstar at work so you don’t get laid off” completely defies the concept of the emergency fund though. Isn’t the emergency fund all about being able to react to the unexpected? Most people think they are rock stars (even though they’re not), and very few know a layoff is coming. Sometimes and entire department is wiped out – top performers and all. It’s just the way it goes! I think 6 months cash is overboard. But I keep at least 2-3 at all times.
@Darwin’s Money, I think if people are realistic with themselves, then they should know when to start preparing for a layoff and when they shouldn’t. It’s not going to catch 100% of the layoff situations, but it will catch most. I would, however, say that you if you don’t have a college education then your job is probably at risk no matter how good you are. It really does depend on the situation.
@Kevin McKee,
“I think if people are realistic with themselves, then they should know when to start preparing for a layoff and when they shouldn’t.”
I’ve known a lot of people who were laid off and NONE of them had enough warning to truly prepare if they weren’t already. People almost never know about layoffs months in advance. They often don’t know until that very day. The reason isn’t because they’re not being “realistic with themselves” — what an insult! — it’s because upper management has a strong interest in keeping layoffs quiet until the very last minute. They don’t want panic, they don’t want retaliation, they don’t want people looking for other jobs and bailing early. They will tell people what they want to hear until the last possible moment and no one is to blame if they didn’t see when it was coming. They are, however, to blame if they had the ego to think that they wouldn’t be laid-off ever and therefore didn’t prepare.
@Meg, I’m not suggesting people know in advance whether they will be laid off or not. I’m suggesting they take a look at themselves, their job, the people around them, and then decide if they are at risk of losing their job. For example:
-Does my job require a specific college education and specialized training or skills that are relatively uncommon? (having a college degree that doesn’t apply to your job doesn’t count)
-Is my job an essential function for the business? (if not, it doesn’t matter how good you are at it)
-If I quit today, would they hire someone new to replace me? (if they would absorb, or if they wouldn’t be scrambling to replace you, then you’re expendable)
-Am I a top performer? (Many companies give employees feedback and some kind of rating. If you aren’t the very highest rating, you better work harder)
If you can answer “yes” to all four of these questions, you aren’t going to be unemployed. There’s no way a company is going to let a person like this go as long as they are solvent. And if the company goes under, you are good enough at what you do to go to a competitor and get a job with them.
It’s 9.5% unemployment, not 95% unemployment. 9 in 10 people have jobs; don’t be the 1 in 10 that doesn’t.
your advice be a rock star at work is really questionable. first of all. this comes with a price that is in general neglecting family… that could cost several emergency funds alone. second. most people could be doing better on their own, instead of being slaves. ….
@Alston, There’s nothing wrong with putting family first, but if that comes at the expense of being great at your job, then you should be prepared to lose that job. And if you want to work for yourself, I think that’s great. It’s a different financial situation when you are self employed, but “different” can be much better if you do it right.
Unless the company that is laying you off goes bankrupt, aren’t you entitled to receive a severance package based on your years of service? Sometimes that alone could be all the “emergency fund” you need to get you back on your feet and into another job.
@Echo,
Nope. You’re not entitled to anything unless you have it in a contract. And, in my experience, most companies don’t do that.
@Meg,
Maybe that’s just a difference between Canadian and American employers, but I was under the impression that a worker is entitled to receive 1 week severance for every year employed.
Some of the other issues you explained earlier sound beyond belief and would never happen north of the border. Firing someone for getting pregnant, are you serious? If that is happening there are some major labour relation and employee rights issues in the U.S.
@Echo,
Nope. Severance is pretty rare — at least around where I am (which is in the U.S.).
Yep, quite serious. I live in a state where they do not have to have a reason to fire you. So while there are reasons they aren’t *legally* allowed to fire you for (such as race or religion), it’s next to impossible to prove even if they do because *they don’t need a reason to fire you*.
Employee rights definitely suck in the U.S. My husband makes good money and we consider his job a “good” one for the area so I hate to complain, but he’s had a hard time taking vacation days and not working 100+ hours weeks (no overtime pay, either). We’re lucky to have health insurance (many people we know do not), but it’s still crap. We have very little choice about doctors and whenever we have anything done, it ends up being far more for us out of pocket than we were originally estimated (another good reason to have an emergency fund). Bills just show up afterwards and they expect you to pay. It’s a mess. And he has no retirement plan whatsoever through work.
For most people we know, it’s much worse — no health insurance, often no vacation days, often fired if they get sick and have to take off days. It’s tough. It’s very hard for people to get ahead and the recession has just made things harder :(
I think your insurance tip was the most cogent because you never know how long it might take for you to find a job or if something happens. If an event leads to you being out of work you want your family covered.
Wow, controversial subject does bring in a lot of comments! :)
Kevin is a young single guy and he can take on a lot more risk than an older married guy like me.
His advice is good for people in their early 20s who can take on a lot of risk.
I am no longer a rock star at work and I am beefing up my saving/passive income to prepare for that day.
One thing I learned is this – everyone is replaceable. Don’t think you can’t be replaced by a younger, cheaper, smarter, and better looking guy. ;)
@retirebyforty, everyone is replaceable but if you’re very good at a vital job function, they won’t want to replace you.
My emergency fund is my home equity line of credit. I can tap it any time I need it and, right now, the interest rate is very low. Of course, that could change over time as the rate is tied to Prime, but at least for a year or two, it is a buffer to allow me to borrow if needed at not only a low rate, but with the interest paid being tax-deductible.
@Ira, Sounds like a good plan to me. Sounds like you have your other money put to work for you in other ways, and you have a way to pay bills if an emergency were to happen.
I disagree.
Everyone needs some margin of safety, some small emergency fund. For some folks, it many be thousands, for others, it may be hundreds. Life happens. If you don’t plan a bit for the unforeseen, you will forever be surprised by it.
Until an emergency happens to you, you’ll feel this way. Afterwards, I promise you’ll change your tune.
@My Own Advisor, Did you miss the part where I planned extensively for the unseen via insurance and investing in accounts without limitations on withdraws so I can access money if I need it in days?
@Kevin @ Thousandaire.com, I just realized that sounded a bit snarky. The point I was trying to make is that it seems so many people are looking at my plan as if I’m just betting there won’t be an emergency and if there is I’m screwed. My plan has multiple levels of protection from an emergency AND it’s not forcing me to miss out on high investment returns.
Hi, Kevin,
I get the feeling you were never a young adult with a minimum wage job sometimes walking to work because I didn’t have enough money to gas up the car.
That’s behind me, but these days it’s incredible to see someone write that so long as you’re a superstar at work, you’ll never be fired or you’ll get another job right away. If you’re in the wrong job at the wrong time (say, when your company has just been taken over), you’ll lose your job no matter how good your appraisals look. And if your area’s economy is slow in your area, you may never have another job that pays as well, or any job.
You may be willing to move, but if you’re like most people (or have listened to conventional financial advise), you own your house. Where will you get the money to ride the bus to a new city and pay rent while you’re looking for work – not to mention pay your back home mortgage?)
I’m not even moaning and groaning about this. It’s an inevitable part of the globalized economy and on the whole it makes our country stronger and richer.
But it also means that people must be smart, and prepared to make fast changes when necessary.
I also agree that everybody should try to have multiple streams of income. Some people have used the time freed up by a layoff to make themselves rich. But it doesn’t happen overnight, and in the meantime the children want to eat . . .