Emergency Funds: A Necessary Ballast

Ballast

One of the bedrocks of personal finance is the need to have an emergency fund. It’s like a foundation in a home. A home without a strong foundation is very suspect and can come crashing down when strong winds or other natural disasters come visiting. In fact, some experts do not even recommend that you start investing in the stock market unless you already have your emergency savings fully funded. For full definition/explanation of an emergency fund, see this post.

HOW MUCH IN EMERGENCY FUNDS?

Now, most personal finance experts recommend 3-6 months of your monthly expenses in your emergency fund. Some people often mistake this to mean 3-6 months of your monthly income. But it’s not. It’s just the sum total of what it takes to run your household every month. Here we’re talking about your basic expenses like rent/mortgage, utility bills, transportation, cost of maintaining all your insurance premiums etc. You get the idea. If you’re a single income family, your emergency funds should be closer to 6 months and if you’re a dual income family in stable industries, it can be closer to 3 months. For immigrants who still have a lot of family members back home in their original country, it’s wiser to keep closer to 6 months in emergency funds. Why? Because your emergencies are double-barreled: your aging mother back home could get sick requiring emergency hospitalization which often requires an upfront cash deposit. And this could happen at the same time that you just lost your job here in the States. Yes, sometimes, when it rains, it pours. Remember Murphy’s law.

Now I get that a few in the personal finance world do not believe in keeping emergency funds…like this guy. They’d rather get that money working for them than have it in a dull savings account yielding 1-2% annual interest. For these kind of people, they rather use a credit card if needed, in case of emergency and then pay it off later. And in a worse case scenario, they will just sell their investments and get out some money. This sounds nice and fun, except that sometimes in real life, your plans get knocked over and fail. And even for the most disciplined, sometimes, you lose your grip and are not able to pay off your credit card balance in a month and those pesky charges and interests start accumulating. Some things are better done old school and kept simple. I belong to the camp that says to keep some cash in emergency savings…you just never know!

GOVERNMENT SHUTDOWN WITHOUT EMERGENCY FUNDS

The last few weeks is a recent example. The stock market experienced intense volatility and December 2018 was said to be one of the worst Decembers for the stock market since the great depression. As fate would have it, at the same time, the federal government shut down also started around this time. So some federal workers were furloughed because of the dysfunction in DC. It was as if the Grinch stole their Christmas. These are real people. I sincerely feel for some of them.

The reality remains that >70% of Americans live paycheck to paycheck. Just the loss of one paycheck can lead to devastating financial consequences for these people. So imagine a federal worker, living paycheck to paycheck, being furloughed at the same time that the stock market was crashing. Even if he had investments in a taxable account that he can sell, it will be not be optimal to sell in a down market (the mantra is to buy low, sell high, right?)

Besides, there are some bills that cannot be paid with credit cards. For example, most landlords and most banks will not accept the use of a credit card to pay your rent or mortgage. And what happens if you max out your credit card limit and have no money to pay it down? You wouldn’t be able to use it further. Sometimes, it’s better to keep things simple and avoid complicated stuff. So I still prefer emergency funds in cash: a high yield online savings account or money market account with check writing privileges is my preference.

WHY AN EMERGENCY FUND?

Well I’m glad you asked. You do need an emergency fund because you’re going to have an emergency. I’m very sure of it. It’s a matter of when, not if. Some people call it the rainy day fund. And that’s quite fitting. Because it will rain. I’m positive that it will rain this year. I don’t know when, but it will happen. Keeping an umbrella with you (rainy day fund) will help keep you from getting wet. I know that for the purposes of discussion, some people often believe they are in stable jobs. In the real world, there is really no such thing. Anybody can lose his/her job. Even in the most stable of professions. I know because it happened to me.

I LOST MY JOB….AS A DOCTOR

As a physician, the standard belief is that medicine is a very stable career path…and it is, for the most part. But it doesn’t mean that you can never get unemployed as a doctor. A couple of years ago, I came to work at my clinic one summer morning and opened my work e-mail only to read a terse message from our hospital CEO stating that due to some difficulties, the hospital will be shutting down in 2 weeks. Boom, just like that. No prior warnings. Only 2 weeks notice. The hospital was filing bankruptcy so we couldn’t even sue them for some of the money we were being owed. In 2 weeks time, it was all over. All the jobs were gone (physicians including Hospitalists, Pediatricians (like me), Cardiologists, Obstetricians, Radiologists, Anesthetists, Surgeons, Nurses, Para-medical staff etc).

What was more interesting to me was to see some of the highly-paid specialists hustle to register themselves for the relatively paltry weekly unemployment benefits. It was pathetic. Now, granted, I got another job soon enough, but it took 3 months before I could start the new job. That was 3 months of no income. And this was never planned, so no time for you to prepare and save ahead of time. I remember talking with one of my physician colleagues at the time and he told me that if this happened to him and he had no income for 3 months, he wouldn’t know how to feed his family. This was instructive to me.

I had another experience one time when our paychecks did not hit the bank on the appointed day. Payday was supposed to be Thursday. By the time I came to work that Thursday morning it was like a world war because employees’ accounts were not credited with their pay. Nurses, doctors, paramedical staff and clerical staff were all fuming. They were threatening the hospital. The hospital CEO quickly sent an e-mail profusely apologizing and stating that it was due to an unforeseen technical error. The salaries hit the accounts the next day. But this event taught me how important it is to keep some emergency fund savings. Imagine how freeing it will be to know that in situations like this, you will still be okay and have no need to worry too much. A fully-funded emergency fund is like a ballast and it helps convert a financial emergency into just a nuisance. This way you can still get on with your life without much disruption.

HOW TO BUILD IT UP

In the grand scheme of things, you should ideally pay off your consumer debts before building up your fully funded emergency fund. If you’re new to this, check this post to see how to get started. Nobody in America gets you out of debt faster than Dave Ramsey. You can use his baby steps to navigate your way out of debt. Once all your debt is fully paid off, then use all the extra money that was going towards your debt in building up an emergency fund. Open an account in one of the high yield online savings accounts. Rates are going up, so you should easily find banks with APR of >2%. Check out these ones here.

Keep in mind, this account should be separate from your regular everyday checking account. It should be relatively difficult to get to, which is why online savings or money market account is a good idea. It will take you 1-2 business days just to withdraw this money. This is to shield you from your own natural tendencies. The emergency fund is just for emergencies, not for frivolous spending or to make up a shortfall in your budget. Ideally, you will rarely have to tap your emergency fund. And the funny thing is when you have a fully-funded emergency, financial emergencies become rare in your life. This is a weird thing but quite true.

Once you have opened up your account, start contributing directly to this account with each paycheck. Keep doing this until you have fully-funded it, then stop. Got a tax-refund? Why not use it to fill up your emergency fund first before spending it on something else? In the case that you ever have to tap it, then try and replenish it again after that emergency is over, in the same manner that you originally built it up. Easy enough.

CLOSING THOUGHTS

This post was actually inspired by the on-going government shutdown, currently the longest in US history. As the shutdown stretched towards the 3 week mark, I started reading stories of federal employees that were being financially stressed out by the absence of their paychecks. And some of them started appearing on cable TV shows to discuss their plight. Some could not make their mortgage payment, pay for health care bill of their children and for some, even their utility bills. I read a story of an employee that had to take a loan to make his mortgage payment. I could feel their pain. Hopefully the federal government in DC will come to their senses and compromise to end the shutdown and end the plight of these employees. But the thought that just kept flashing through my mind was: if only they had some emergency funds. If only. Financial stress is not conducive for your health…..what with increased stomach acid from the stress, anxiety, high blood pressure and poor sleep at night. Why live like that? There’s a better way. Sleep better at night. Live a healthier fiscal and physical life. Get your emergency fund and keep it fully-funded. Your future self will thank you!

Do you have an emergency fund? Where do you keep it? If not, why not? Comment below

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8 thoughts on “Emergency Funds: A Necessary Ballast

  1. Awesome post. I’m actually working on a post about where to put emergency funds and my experience with high yield savings accounts, money market accounts and certificates of deposit.

    Would you consider student loans consumers debt? The reason I’m asking is because I saw you mentioned that consumer debt should be eliminated before funding an emergency fund.

    • Thanks for your comment. You know what? I’m a Dave Ramsey fan and I tend to subscribe to his baby steps (Baby step 1 is $1,000 beginner emergency fund and Baby step 2 is paying off ALL consumer debt including student loans; your mortgage is the only debt exempt from this). It’s a psychological thing because the lack of fully-funded emergency funds will scare you to quickly get out of debt as fast as you can (gazelle-intensity) so you can go complete your emergency funds. So, yes, I subscribe to getting out of all consumer debt before fully funding your emergency fund.

      • I like Dave Ramsey as well and the baby steps makes sense. It just can take a while to get out of student loan debt when you have over 200K of debt, but the baby steps makes complete sense. In stead of having a 3-6 month emergency fund you get a 1-3 month emergency fund, which I couldn’t imagine $1000 being enough for most people, but like you said it’s a start AKA baby step. I too am a physician and I’m trying to achieve Fi and get out of student loan debt. It may take me 5-7 years though. Until then I will be taking baby steps.

  2. The $1,000 is beginner emergency fund. It’s not enough for anybody. That’s why you hustle to get out of debt as fast as you can and then go back and fully fund it. WCI recommends getting out of medical school loan debt within 2-5 years. Lots of doctors have done it and i think you can too. Just don’t lose focus. We’ll be cheering you all the way…

  3. Yes you are right. The WCI does recommend 2-5 years and I could do it, but my current circumstances will not allow me to do that. 5-7 years is what will work for me. I have realized that the path to FI is not the same for everyone. Everyone has their own sets of circumstances and family needs, but I will get there none the less.

  4. Very well written post and your own experience of being a doctor and still becoming suddenly unemployed should open eyes everywhere.

    We think wearing the white coat means we are guaranteed a high paying job and that is not always the case. I have seen physicians surprised when they were asked to leave without much notice. A high income in the past would be able to cash flow there expenditures but when that ran dry, they found themselves in trouble.

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