Wednesday, January 03, 2007

Mini-E: Challenging Conventional Wisdom on the Emergency Fund

Personal finance bloggers are nearly unanimous on one thing: everyone needs an emergency fund.

They differ on the amount, but the most commonly cited figure is 3-6 months' expenses. The largest figure I've seen is a full year's expenses. The smallest is usually Dave Ramsey's "baby step" figure of $1000. The most commonly cited reason for using an emergency fund is car repairs. Even more than car repairs, advocates of the emergency fund have to contend with the specter of medical urgency--it happens less, but it costs more.

Now let's consider my situation, and the situations of others my age. No one depends on me and I don't have a car. I'm young, healthy, and employable. And here's one that is unlikely to be true for all but the most recent graduates: my parents could and would cover any serious medical costs that might come up for me in the immediate future and exceed the capacity of my insurance. (Reasoning more likely to be widely applicable: I am only responsible for my own medical costs--no children at risk of appendicitis or bike-related concussion to worry about, and I have pretty good health insurance through work.)

I budget for irregular expenses on an ongoing basis, so seasonal clothing purchases and holiday gifts come out of "buckets" of money designated for those particular purchases. I also budget $30 per paycheck for "unexpected expenses." For me, those are things like, "the bookstore I love is going out of business and I want to pick up some memorabilia on clearance," or, "for once in my life, I want to write an actual, physical letter, so I'll need some stamps" or, "on a whim, I decided to get my healed-over nose piercing redone," or, "I caved and took a taxi home even after I had zero dollars in my taxi budget line." Mostly, though, I don't use it, and it piles up. I'm thinking about instituting a rollover rule so that anytime it hits $200 I push $100 into savings, but in general, this little mini-mini-E fund works for me: it allows me the budgetary flex that is the primary purpose of the E-fund.

Given my particular circumstances, there are only a few scenarios in which I can see an emergency fund being absolutely essential:
1) An unplanned pregnancy. Being able to pay for my own abortion without stress about money would minimize trauma and let me decide whom to tell.
2) Someone I love (and who lives far away) needs me urgently, or I need her/him urgently, requiring that I pay for a plane ticket and other travel expenses.
3) Someone I love needs money urgently and has no other means of getting it.
4) My boyfriend and I break up before the end of our lease and in moving out I incur moving costs in some way I haven't previously considered.

If I lost my job? I'd move back in with my parents, or I'd scrape up $150 for the plane ticket back to [the small city where I went to college and where the cost of living is next-to-nothing] and stay with friends for awhile, or I'd get a waitressing job right quick, or I'd pick up some freelance copyediting work. I'd eat rice and beans and I'd deal.

So for me, I'm okay prioritizing contributing to my Roth over contributing to an emergency fund, to the point that what I had thought might be an emergency fund is actually going to be the seed money with which I open my Roth at Vanguard. I have a $1,000 CD earning next-to-nothing that I wouldn't mind breaking early if it came to that. I can sleep just fine without $5,000 in the bank.

My point is that just as it does for these bloggers, for me, it makes sense to look at my own life, both financial and otherwise, when considering how much cash I need to keep in reserve. Instead of following a rule of thumb, I can create a solution tailored to my situation that allows me to pursue my goals.

15 comments:

mapgirl said...

I think it's perfectly fine to have a CD locked up in a bank and break it when you need the money. That's what defines an emergency. As long as you have it for when you really need it.

The only reason people have so much money locked away is because they have more responsibilities financially than you do. I certainly kept a rainy day fund when I was in college too.

But it's better to have one than not.

English Major said...

Mapgirl, I agree that if I had more financial responsibilities (i.e. people who depended on me, various payments, &c.) I'd definitely want to keep more cash on tap. My concern really is about encouraging people to follow a rule that may not be best on an individual basis.

Anonymous said...

The main point of an emergency fund is to be prepared for unexpected disasters so you won't be screwed (or be forced to make bad financial moves) if disaster strikes.

But it sounds to me like you have thought through almost every conceivable disaster and have thought of a way to cope with it without an E fund.

And in reality, you parents are your safety net. Almost all the emergencies you mentioned could probably be solved by a phone call. There may come a day when you decide you want to have your own safety net and not rely on them, and then you'll build an E fund.

Until then, I applaud your decision to open a Roth instead of letting your money sit in a savings account. It's nice to see someone thinking creatively about how financial principals work for them instead of following the party line.

Anonymous said...

I don't have an emergency fund either.

Lazy Man and Money said...

I don't have an emergency fund either.

(Sorry, previous comment had no user information.)

Anonymous said...

how lucky it is to have "unexpected expenses" like "the bookstore I love is going out of business and I want to pick up some memorabilia on clearance," or, "for once in my life, I want to write an actual, physical letter, so I'll need some stamps" instead of "my child has an unexpected illness and i need to decide to forgo things for my other child so i can may be able pay for his medical bills."

hmm.

Anonymous said...

I'm curious to know what your estimate of lease breaking/moving costs is. Not that I expect you and your boyfriend to break up, but what if one of you gets a dream job offer halfway across the country and the other can't afford to leave the current one? You still end up in the same place, financially.

And once you figure in lease penalties, first/last/security deposit, and some moving expenses, having $1500 ready for that doesn't seem crazy to me. It might be worthwhile to have a few hundred more beyond your CD.

I certainly understand your larger point about your financial responsibilities. Besides, a Roth offers penalty free withdrawals, so that makes a decent backup e-fund. But I get the impression from this that your folks are also your backup e-fund.

Speaking as someone who HAS had to borrow money from her parents, I think you'll feel better if you know that you made the effort to generate some extra savings for yourself before having to go to them. Just something to consider.

English Major said...

Well, that's sort of the point, anonymous. If I had to worry about children, believe you me, I'd want a fat cushion in the bank yesterday so that I wouldn't have to make choices like forgoing things for one to pay the other's medical bills, and I'd make it a priority to get it there. But I don't, and there's no reason I should follow personal finance "rules" that don't suit my personal circumstances. My point in this post is that personal finance should be personal--particular to each individual's priorities. My children are not a priority because I have none. Maximizing the value of my potential to start saving early is a priority for me (and, I might add, it's one that would benefit my Hypothetical Children as well).


HC, I actually wouldn't be breaking my lease if I moved out, because my boyfriend and our roommate would continue to live there, so there would be no penalties that way. What there would be is the unfortunate situation of moving in with my parents and continuing to pay rent on a place in which I'm not living until the lease comes up in July. Then I'd get my deposit back and try to recycle it into a deposit on a new place, but you're quite right that I'd need some spare cash to cover an extra month's rent and any potential excess on the deposit or fees if I used a broker. You're also right that I should shoot to have a few hundred dollars on top of the CD. When I funnel all my available cash into my Roth, I'm going to start new, smaller contributions to a mini-E fund. I also agree that it would cause me substantial angst to have to go to my parents for money--I've tried to anticipate the situations in which that would be most the case (pregnancy sits squarely in the number one spot, but I wouldn't feel so bad about a non-pregnancy medical emergency) so that I can plan to be able to deal with them on my own if they ever arise.

Anonymous said...

I don't have a traditional EF, it's invested. We don't have kids and can pretty much cash flow what is unexpected. We also have a 0 balance HELOC of $60k and CC to float any major money issues.

EFs are great for death, disability, job loss (at least for me that's what it is). Everything else like car, home repair, trips, etc are all planned for, so I always have a lot of cash building during the year for stuff I know is coming like property taxes, insurance, etc. So it's a secondary buffer in cash as well is the building of my "sink" funds.

The EF is mainly for people who are trying to get ahead. Once you're ahead, no debt, set bills, understand your spending, it's a lot easier to not be dependent on one.

Plus if you are dependent on an EF it's a bad idea, say you use it to buy a car when yours dies or replace the roof. Then when you lose your job before you build up your EF, you're in trouble. At my blog I discussed usage of EF.

Matt said...

How do your parents feel about your plan?

English Major said...

Hey matt, without wanting to sound too much like your sixth-grade teacher, that's a good question.

As it happens, my parents would expect me to rely on them in an emergency, both emotionally and financially (and, in addition, are somewhat baffled by my growing financial acumen--they seem to kind of think it's unnecessary). I think they would, in fact, be a little hurt if I didn't (they do a lot of reminding me that I can always move back home, which, frankly, is not something I have any interest in doing outside of a situation that makes it a necessity). There are two major "emergency" scenarios: the first is job loss, the second is illness. My mini-E fund is big enough to get me through one unemployed month. I can't imagine that I couldn't get a job to make enough to cover my rent and bills within a month, but if I couldn't, my parents would help ungrudgingly, if not with absolute glee. In the event of illness, my parents wouldn't think twice about covering any expenses that exceeded my employer's insurance coverage (which is pretty extensive). Fact is, my parents are willing to pay for even non-emergency medical expenses, like getting Gardasil, the HPV vaccine (my mother had cervical cancer at my age because of HPV exposure, and insisted that my sister and I both get the vaccine as soon as it was available). I wouldn't have been able to afford it on my own, since it's very expensive and not even partially covered by insurance, but my parents feel that my (and my sister's) health is paramount, and if we can't afford to pay to protect it, they can and will. This includes things like Gardasil, or second opinions, or specialists--things that I just couldn't fit into my budget even if I needed to--as well as emergency situations.

I recognize that this is a privilege, not something that every child can expect from his or her parents (because of the exorbitant costs of a high level of health care). I'm glad to have it available to me, though I don't plan to take advantage of it for too long. I wish it were available to everyone.

RJ said...

I haven't been keeping much of an emergency fund for my own purposes, as I have a stable job (tenure) and good benefits.

However, as I've gotten older and as I've seen my parents age, I've realized that I should have some sort of EF for reasons related to them: an emergency plane ticket, rental car money, funds to cover a couple of months of *their* bills, etc.

Though my parents have never been particularly bad with money, they've never been particularly great with it, either. My dad is good at paying his bills, managing his various lines of credit, using Quicken, etc., but he's not been adept at building wealth and keeping cash reserves beyond $30,000.

Anonymous said...

EM,

You hit it on the head. An E fund should be based on your personal needs and not some # anyone else tells you.

Good luck,

CD

Anonymous said...

I don't think I need much of an emergency fund either. Like you, I have no car. I am married but have no children nor plans for any. If I lost my job I would qualify for employment insurance (which is NOT sponging off the state because I pay into it on every pay cheque) which I already know from experience is sufficient to live on. As for unexpected medical costs, lets have three cheers for Canada's free universal health care! I figure I do need a certain amount for a plane ticket if my parents were to get seriously ill, or some other small problem.

Margo said...

I would double-check with your insurer about Gardasil. I originally started the regimen in February, and my doctor didn't have it in-office. So, I picked it up at the pharmacy and paid the whopping $158/shot twice.

Then later I find out that it IS covered - not as a prescription, but as an "office visit". So, Gardasil doesn't show under the BCBS prescription coverage but it is covered.

I had to take my receipts from the pharmacy to the doctor, let them bill out for it, get reimbursed, and then in turn reimburse me.

Ridiculously complicated, but at least I'll get the money back sometime in the next month or two.