Ben at Money Smart Life has brought together a few different bloggers to answer the question “Can You Save Too Much In An Emergency Fund?” I was one of the bloggers responding. For me, an emergency fund of $1 is too much lost in opportunity costs.
In day 2 of the series, Ben asks “Can you be too conservative with your emergency fund?” I don’t give my thoughts on that specific question, but I’d say that you really can’t be too conservative. The money has to be as liquid as possible and for that to be the case, you really don’t want any volatility.
In day 3, Sun’s Financial Dairy gives his detailed emergency fund. So stop on by, there’s a lot of good emergency fund talk going on at Money Smart Life.
I think if you keep your emergency fund in high yield savings account and or t-bill (as suggested by Sun), it’s also just another way to diversify your investments. The only place that’s truly putting your money to waste is a zero interest checking account.
I’m with you in forming the view that emergency funds are wasteful (although I’ll concede that some may need them).
I like Lazy Man’s suggestion of using a HELOC as your emergency fund. It gives you access to quick cash if you need it and doesn’t tie up thousands of dollars in low interest holdings. I’m definitely going to look into it. If you never have to tap into it, I guess the only cost is the home appraisal and any fees required to open the HELOC.
Too bad New Century went bust or I would have gotten a HELOC on my cardboard boxes. :)
I don’t agree with the idea of using a HELOC as an emergency fund – in the event of job loss, it increases expenses just at the time when income goes down.
Lazy Man says
It’s best in a two income family where you can get by on each income by itself. I have a unique situation where job prospects are nearly limitless as a software engineer in Silicon Valley. My fiancee has the equivalent of tenure at her job. That said, if you lost your job, you could always liquidate your investment holdings. If you’ve been diversified and have held the securities for 5 years, you’d likely have the same amount saved as if you put it in high-interest bank account.
Actually, living in Silicon Valley is a good reason for a big e-fund that isn’t debt-financed. We probably do have too much in our E-fund – a year’s living expenses in I-bonds assuming zero income – but my experience in the Valley has taught me that if you’re going to be footloose and fancy free in your career and spend it in startups, you need to be conservative on your finances. Startups often involve periods when you go unpaid, and the older and more senior you are, the longer it takes to find a job, particularly with good startups, where you have to be just as picky about them as they are with you.
For me, one rather scary experience was Silicon Valley’s dry years starting with fall 2000. The “bad market” lasted until about 2004, which was enough to drive lots of people out of the Valley. Fortunately, I was unemployed for only a couple months during that time, but I would have had an even harder time sleeping if I was using debt to pay bills every month.
Another thing: we use a bigger e-fund as a form of self-insurance. We don’t carry collision or comprehensive on our cars – just a whole lot of liability. We also have a maximum deductible on our homeowner’s insurace. Our approach to insurance is to go for wealth preservation and not bother with cashflow preservation, and this approach means running with a bigger e-fund.
That said, our investments are now not far from the point where they generate enough income to pay our living expenses, so we may start moving money out of the e-fund and into more higher-yielding investments.
Lazy Man says
Good point Foobarista. I tend to only go to well funded start-ups where I will not go unpaid. I’ve only been two at this point, but I’m only 31 and I’m 2-for-2 in the last 3 years. I realize tha the bad market can come back, but my fiancee’s job as a military/government pharmacist can cover both of us. Even in a bad economic climate the gov’t pays.
“That said, our investments are now not far from the point where they generate enough income to pay our living expenses” That’s what I’m trying to drive towards and a traditional emergency fund would set set me back over a year.
Certainly, you’re in a different situation than us: I’m the person with the “stable job”! My wife is a commission-only business broker and can go several months without income, followed by a big pile of income when she closes a deal. So, to deal with this volatility, we assume we’re going to live on my income and save all of hers. Since it’s quite likely that if Silicon Valley has a downturn, we’ll both be hurt, we run with a bigger e-fund.
Well, it’s not just living expenses that need covering (although that’s what I mentioned) – what about medical emergencies? Divorce? It can all happen at the same time – the job market dries up, one of the spouses needs a $15,000 surgery and then divorce. I know everyone’s situation is different, but I don’t plan on everything being the way it has been for the last three years, or for how it is today, I plan for the worst case scenario. But having investments you can cash out is a lot different than a HELOC.
Lazy Man says
Well you’d have both assets you can cash out and the HELOC. I’m not advocating just spending the money that you’d save in an emergency fund. I’m advocating saving it and investing it in something that earns a better return.
The biggest knock on the stock market is that you can’t depend on it in the short term. I’m advocating the use of the HELOC to help mitigate that risk. I think there are a lot of people who keep a lot of cash on hand missing out on thousands of gains, for an emergency that never happens.
If you had invested that money wisely, you’ll be much more prepared for bigger emergencies in the future.
This sort of stuff is all about what lets you sleep at night. If what keeps you awake is “upside” worries about missing out on fat returns, maybe the heloc & invest strategy is better. If what keeps you awake is “downside” worries like not running up debt if the economy tanks and takes your job with it, having a big e-fund is better.
The danger with ignoring the downside is that you could have the stock market tank, lose your job and face an awful job market, and simultaneously have real-estate tank. This has happened at least three times in my lifetime and career in the Valley: in 1982, 1989, and in 2000. In the 1989 case the downturn lasted for several years and RE didn’t recover until 1997. In the 2000 case, real-estate bounced back by 2002, but the job market sucked until 2004.