I am a big proponent of having an emergency fund. In fact, one of my medium term goals is to have a $10,000 emergency fund (about 4.5 months of living expenses). So you may be surprised to hear that I recently took $4,000 out of my emergency fund (balance was at $6,200 at the time) and used it in a way that I feel is much more productive.

Where did it go?

That $4,000 went right into my Roth IRA. With my goal of maxing my 401(k) for the year, I knew it was going to be tough to max the Roth in 2010. However, I know that these early years are the most important for the growth of my Roth. Somehow, someway, I was determined to make sure I was able to contribute the full $5,000 for the year.

With both retirement accounts getting maxed for the year, I know my investment accounts are going to grow at a faster pace than I could have ever hoped. A little bit of sacrifice now (and it really is only a little bit) will set me up for that boat and house on the beach that J. Money and I always talk about for our early 40s.

What happens if an emergency occurs?

Well I am glad you asked. I still have an emergency fund of about $2500. So, I am covered for at least a little bit. I also have additional cash savings (set up for specifics savings goals) that I can spend if I am really in a tight spot. There is also a $1500 cash buffer that I keep in my checking account. All in all, I am at about the same place I was cash wise prior to the $4K being yanked out.

You then ask, what happens if I burn through all of that cash?  Well I am glad you asked, because that was a legit concern of mine as well. I consulted with a financial advisor (someone who is 30 years my senior and specializes in retirement accounts including the Roth IRA) and found out an interesting aspect to Roth’s. Now, we already know you can take out your principle investments at any time without penalty. We also know you can’t put that money back in until the next tax year if you have already maxed your contribution for the year. BUT, you CAN take out principle funds from your Roth for a maximum of 60 days and return them in full without penalty once over the course of a year. If you return the funds within those 60 days, it’s like it never happened.

This was all the reasoning I needed to make that jump.  If I can have a 60 day loan from my Roth with no stipulations, I know all my financial bases are covered.

Why did I do it?

Well, I explained what I would do if an emergency occurred above, but that doesn’t get to the fundamental logic for me making this bold move. While I embrace an emergency fund, I do so begrudgingly.

Cash is cash, and having ample cash reserves is important. Does it matter if it’s in an ING sub account labeled as “emergency fund”?

While having that $10,000 e-fund is important to me, it is only a mid-level priority. Maxing out my investments in mutual funds (especially my Roth in my mid 20s) takes priority over almost all other financial decisions I make.

It certainly also helps that I have diversified my income over the past two years and that I have a position with my employer that I feel is extremely secure.

What do you think?  Have I made another personal finance sin?  Have I gone absolutely mad because I feel the emergency fund isn’t the holy grail of my personal finance life?  Let me know your thoughts below.

It’s taken almost a year, but now every stray dollar that is associated to my name is now in my possession. This thanksgiving I picked up a few bonds and stock certificates that I ‘owned’ but didn’t have in my possession. Now, the question is where to allocate this ‘found’ money?

401(k), Roth IRA, Emergency Fund, Brokerage Account? There are so many options and all are viable vehicles that could use an influx of cash.

This decision comes down to priorities. Next year I may be able to max out my 401(k) and get my bitchin’ employer match, but if I do this, it’s likely I will not be able to fully fund the Roth. At the same time, my emergency fund is only around $3.7K. I never set a specific goal, but $10K sounds appropriate so I will need a boost to get there within the next year.

When you have excess money, what is it you do?

I think I will be looking at cashing in the bonds to boost my emergency fund. I may have to run the numbers to make sure this is wise though. 2010 is quickly approaching and I have yet to calculate my expected costs. Until that is done, I can only make some assumptions as to what is best.

Of course, my colleagues in the Personal Finance world will be happy that I have finally come around on an emergency fund after so boldly claiming that I didn’t need one several months ago.

Lastly, December looks to be an exciting month as it is a three paycheck month at my day job. It looks like that emergency fund will be getting at least one boost this month.

A handful of people will remember my post on why I, and people in similar situations as myself, didn’t need an emergency fund. I am not going to disagree with myself, however, I have had a change in my situation since I wrote that a bunch of months back; I bought a new car.

There is a lot to be said for having an emergency fund (which I look at as a “you’ve been laid off” or “someone took a blowtorch to your house” fund), and I didn’t feel the need for one until my car payments kicked in this month. I changed the name of my “new car” savings account to “emergency fund” on ING, and dumped a few thousand dollars in there, giving me about one month of spending, saving and investing (or about 7 weeks of just spending). That’s not bad, but I would like to build it up to 6 months of expenses. That of course will take time.

Why I Now Have an Emergency Fund

The change in my philosophy is purely emotional. I doubt I will need an emergency fund, but with the new car, I fear a day when I can’t afford rent or my car payment. Knowing it’s not likely to happen doesn’t mean I don’t think and feel that it’s smart to have one of these “oh shit!” funds

How Do I Build My Emergency Fund?

The next question for me is how much do I put into the fund each month in order to reach that 6 month goal?  Right now I am going to put $100 a month in there.  At that rate it will take years, in fact, the better part of a decade to build up to my six month goal.  I feel like I should ramp that up a bit, but I am stretched pretty thin with where the my money is being allocated (investments, savings, food, rent, etc.).  Slow and steady is the approach I am going to go with for now, however I reserve the right to alter this saving philosophy whenever I see fit.  Interestingly, Mrs. Micah wrote about this very issue (saving fast or saving slow) in her article for today.  You all should give it a gander.

Where does funding an emergency fund fall on the list of priorities for everyone else?  Should I fund this faster than my trip to Rome I was hoping to take in two years?  Should I focus skip my Roth IRA next year to stack the fund? (Probably a really dumb idea at the age of 25). Let me know your thoughts.

What is an Emergency Fund

An emergency fund is a pool of money that has no allocated purpose other than to be available to you quickly in case of an emergency (health issue, car accident). It isn’t there for frivolous wants, but solely for the unforeseen expenses that will have a drastic effect on your finances.

People often ask how big of an emergency fund they should have. Most people recommend that you have enough money available in your fund to cover anywhere from 1-6 months of expenses (including your mortgage or rent). This is to ensure you can financially survive a traumatic life experience such as a job loss or a stack of unexpected medical bills.

Who Needs and Doesn’t Need an Emergency Fund

Having an emergency fund is never a bad thing, but I don’t think it is as high of a priority for certain individuals as other bloggers and personal finance experts believe. If you have a young family and a house, yes, you absolutely should have an emergency fund. If you are in your early to mid 20s (like myself and several of my readers), are renting and don’t have a family to support, you simply don’t NEED an emergency fund.

What Should I Do with my Money that I Don’t put in an Emergency Fund?

First things first, pay off your debt. If you are in debt, get serious about it and throw every penny you have at getting out of that hole. It should be noted that if you have been working to get out of debt lately and didn’t have an emergency fund set up, did you need one in all of that time?

Second, invest in a Roth IRA. The reasons why this is step number two is explained below. A Roth IRA is an asset unlike any other, and if an emergency doesn’t happen, think of what that money can turn into over time (please see my post Turning $5,000 into $110,000 (Tax Free) – All it takes is time.  It’s safe to say whenever you have extra money, a Roth is probably the best place to put it.

Third, create sub savings accounts. Save money for your short to medium term goals with the money that you have left over.

Fourth, create a buffer in your checking account of a few hundred dollars (maybe $1000) to make sure you don’t overdraft your account when a bill is higher one month.

What Happens if an Emergency Occurs

Well, you tried to play the odds and hope that no emergencies would take place. Unfortunately disaster hit and now you need cash, and quickly. Don’t sweat it, just because you don’t have an emergency fund doesn’t mean you are screwed. You have several options in front of you.

• Option 1: I know no independent 20something wants to hear this, but ask your parents for money. This is an emergency and families are there to support one another. Swallow your pride a bit and ask. It may make things easier in the short and long term.
• Option 2: Take the cash from your short to midterm savings goals. I guess your trip to Paris isn’t as important anymore in light of the recent emergency or you may have to hold off buying a new car in two years (may have to push your goal back by a year or two, but hey, life happens.)
• Option 3: Take your contributions out of your Roth IRA. This would royally suck to do, but it is a legitimate option. You can take your Roth contributions out at any time without penalty. The caveat is that you can’t put them back in as if your Roth gave you a quick loan. If you have been putting $416.66 a month into your Roth to hit the $5,000 contribution limit, it’s possible that you have enough in there to last you a few months should something disastrous happen. (Please note: you can take earned money out of your Roth without penalty if you are paying significant unreimbursed medical expenses or are paying medical insurance premiums after losing your job.)
• Option 4: Charge it. Yes, it would suck to go back into debt, but if you were that focused about getting out of debt in the first place, you can surely do it again. Think of all you learned getting out of debt the first time, and think of how much easier it may be to get out of it a second time if it was a necessity.

How to Prevent an Emergency from Happening

If you want to avoid using your already established emergency fund, or if you are like me and don’t have a designated fund for emergencies, you should focus on preventing them from occurring. Here are a few tips to help prevent an emergency.

1)Get regular medical and dental checkups (this is the best preventative maintenance you can have and will make sure your body is in tip top shape)

2)Stay active. Eating and being healthy is easier said than done, but if we could all focus on this a bit more we are less likely to have expensive problems down the road.

3)Keep up with the maintenance on your vehicle. It’s amazing how many people equate their livelihood to their car. If your car gets regular checkups like your body does, it will last a lot longer.

4)Pick up a part-time job. Diversifying your income is the best way to hedge against job loss. Even a few hundred dollars a month is going to help you if you get laid off. This extra income can help boost your savings or Roth contribution; helping you in case an emergency does pop up.

I definitely don’t expect everyone to agree with me about the necessity of an emergency fund, but please remember I am only advocating this strategy as an alternative to younger adults who could be boosting their savings in the years when an emergency is least likely to happen. I personally don’t have an emergency fund, but I do have targeted savings goals and a Roth that I can tap into if necessary.

Please leave a comment and let me know your thoughts about this break from the personal finance norm of having an emergency fund.