Hey everyone, it’s Finance Fridays again. Recently, I’ve been considering cutting down my emergency fund. So today I’m going to talk about “Do I really need an Emergency Fund?”

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Do I really need an Emergency Fund?

Conventional wisdom is that your emergency fund should consist of 3-6 months of “fixed expenses”. For example, a mortgage payment, loan repayment, food/water, etc. Basically, it should be enough to keep the household running for a certain period of time in the event of an emergency.

For example, if you were to become temporarily disabled for a few weeks or a month or if you suddenly lost your job. If you have an emergency fund available, you would still be able to continue on without the normal incoming salary for a certain time period. This is usually 3-6 months time, depending on how aggressive or conservative you are.

However, every family is different. If you have children in private school or multiple car payments or other recurring expenses, then that is probably also in your list of “fixed expenses” that you must take into account. Also, if you have an investment property that could potentially be vacant for a month or two during a down period, you will need to be able to eat that second mortgage cost as well.

For me, my fixed expenses will go down a little bit starting next year with a relative increase in household income. My daughter will be beginning public school in the fall so we won’t have to pay for preschool anymore. You can also add in that both my wife and I got small pay bumps this year and that I finally paid off my car from fellowship. (not the 3rd car, which I bought used outright) This amounts to us having a little more money every month to put toward things. However, I’ve already allocated this “extra money” to paying off our loans and increasing our 529 contributions.

So why cut down your Emergency Fund then?

Well, another thing happened this year as well. We paid for our solar panels out of pocket meaning we had to put down a pretty hefty amount up front last year, early 2017. For most of 2017 we were running on a smaller emergency fund than previously, probably 3 months instead of our normal 4-5 months emergency fund. It was a little worrisome at times and we had some unexpected expenses come up, like needing a new Air Conditioner, amongst other things. Even so, I was able to come to the realization that we probably didn’t need 4-5 months of an emergency fund.

Also, it really hurts to look at the miniscule interest your emergency fund makes in a savings account.

Can’t you just put more money into a Taxable Account?

This is true.

However, what if the market takes a downturn at the same time a big ticket expense comes up, like the need or a new roof, or to renovate a bathroom because of a leak, or something? You would then be at the mercy of whatever the market would give you to pull that money out (likely at a huge loss) and pay for it.

The key to everything is understanding what your risk tolerance is and what your financial situation is.

I still believe that we should all have Emergency Funds. However, the amount you hold in your emergency fund is variable and really depends on your financial situation.

If I was a young, single guy, like I was in residency, I could get by on a very small emergency fund. As long as I had enough money to pay for rent every month, I could survive on ramen and $1 cheeseburgers from McDonald’s if I needed to. However, I have significantly more responsibilities than that of my 28 year old self.

It also is important to see what options would be available to you if you needed to get money quickly. Could you get a Home Equity Line of Credit (HELOC) in a pinch? Can you get a low interest loan from somewhere, like your 401k? (or in my case, Thrift Savings Plan) Neither of these are great options of course, but life can throw you curveballs sometimes and you should be aware of what your options are.

I see, so what are you going to do?

I’m still pretty conservative, so I’m going to cut down our emergency fund from 5 months to 4 months. This, after seeing how this year goes, I may go 3 months in 2019.

However, I don’t think I’ll ever go less than 3 months.

Life can be very unpredictable. You never know when you need to make a large home renovation or have a sudden medical emergency or some other large cost item. The emergency fund is there for those kinds of emergencies.

What about Money Market Accounts?

In general, I don’t like Money Market Accounts for an Emergency Fund.

The minimal interest benefit they have over a savings account pails in comparison to increased restriction and decreased liquidity the accounts provides over a conventional savings account. Some many disagree with me on this point, and may even keep all or most of their emergency fund in a Money Market Account. I can’t fault them for thinking like that.

My concern is that if an emergency does happen, you won’t want the restrictions that come with a Money Market Account. The kind of risk for such little interest benefit isn’t worth it to me. However, like I’ve said, I’m very conservative.

Conservative?

Yes.

Overall, I’m pretty risk averse (conservative) when it comes to my finances and retirement. A good friend of mine wanted my opinion on buying investment property. Apparently a friend of his was getting a HELOC on his house in order to purchase another place to rent. Then the plan was the rent would be enough to cover the second mortgage on his house. In this situation his house is worth significantly more than any investment property he buys, so he’s just rolling another house payment into his current mortgage. The long term plan was to pay off the second mortgage while paying off his first mortgage and adding more investment properties as his main mortgage decreases.

This is called being very leveraged. It could work out great assuming your properties all appreciate in value and you can keep your investment properties rented out. However, it only takes one “bad winter” where you can’t rent out your investment properties and then you can’t afford your own primary mortgage. In that case, you may need to take out other loans to cover you, or your bank(s) will start to come after you. Trust me when I say that a bank is more than happy to loan you money if you jump through all their hoops and get through their underwriting… however, if you think your bank will “give you a break” on missing a few mortgage payments, you’re wrong. One “bad winter” and you could see all your gains lost in an instant.

I’m not saying people shouldn’t be leveraged. That’s a personal opinion. If I was a young, single dude and I wanted to make an aggressive investment play, then sure, becoming heavily leveraged in properties is a consideration. However, we must remember, high risk – high reward. With my current financial situation and responsibilities, I can’t afford a risk like that.

This all goes back to The Philosophy.

You’re a doctor, you make reasonable money, and you should have a reasonable lifestyle. In terms of retirement, you’ve already won — as long as you stay the course.

Watch the balls go by and collect your walks.

Just remember that while “the enemy of good is evil”, don’t forget that:

“Better is the enemy of good.” or if you prefer “Perfect is the enemy of good.” – Voltaire

Interpretations vary, but my interpretation is this one from Wikipedia:

The original meaning may have been that attempts to improve something may actually make it worse, similar to the sentiment expressed in the maxim “leave well enough alone“. Neither the Shakespeare nor the Voltaire construction suggests perfection, only improvement, lending support to this interpretation. (emphasis mine)

It’s ok to want to make the maximize your money for retirement, that’s why we’re here.

However, just remember to keep your eyes on the prize – retirement or early retirement, not necessarily “making it rich”.

TL;DR

I’m probably going to cut down my Emergency Fund to 3 months (from 4-5 months).

However, I think an Emergency Fund is still important.

Don’t forget The Philosophy.

“Better is the enemy of good.”

Keep your eyes on the prize.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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