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Stormy weather ahead: Increasing my emergency fund

March 4, 2008

Meg at World of Wealth wrote a post sure to put a little black cloud over your day. She is advising us all to stockpile cash now. While I don’t necessarily agree with all her points, I can’t make a convincing argument against them either….. Everything mentioned is a possibility.

In short, Meg’s post scared me! These thoughts have been festering for some time now and her post brought them back to the surface. I’m not one to panic and am generally optimistic, but it did prompt me to evaluate my goals for the year. I don’t think this is an irrational panicky reaction to all the doom and gloom as of late, but let me know if you think I’m going overboard.

Let’s talk about my emergency fund goal of $10,000. I think this is quite a respectable little emergency fund for someone my age. Especially if I were still living in Iowa and paying $575 in rent each month, and using about one tank of gas each month. However…. My rent went up by, oh, $900 each month, and my efund goal stayed the same. Is that realistic? Hardly.  I could always go to my family for money, but I don’t really think my parents stockpile cash. I wouldn’t be shocked if I have a bigger emergency fund than they do. They aren’t exactly pf role models, though they are hard workers. Anyway, who wants to borrow money from family? Total last resort. Like, after scrubbing toilets for a living and moving under the bridge. (Well, maybe before that… But only slightly.)

So, what is a more reasonable emergency fund? I’m much more comfortable with at least $15k, probably closer to $20k. I don’t think I’ll regret building up my cash. Eventually, I will want to purchase property, and it takes years to save up for a down payment.

I’m going to alter my 2008 goals. I can leave the $15k retirement contributions as a goal, but count my employer match in that. It is vested immediately, so I’m not counting chickens before they hatch. I wasn’t planning on counting it because it is transparent to me, but it is part of my overall compensation package. I’ll contribute 8% and get a match on 6%, and also fund 5k in a Roth IRA. That’ll bring me in just under $15k.

Next, I’ll knock down my 401k (currently at 14%) by that same 6% and put the difference into my emergency fund. My 2008 year end goal is going to be $15k in my efund (increasing it by about 7k). After that, I’ll evaluate if I want to increase my cash reserves further. Sidebar has been updated

I seem to have problems with yearly goals. I must have goal ADD, because I always change them mid-year. I’m changing them in March, and I didn’t even set them until late January at the earliest. Still, it is silly to stubbornly stick to those goals when these goals make more sense.

Side Note: Mrs. Micah has created a personal finance wiki! Check it out and add your blog if she missed it.

16 Comments leave one →
  1. March 4, 2008 6:35 pm

    Thanks for mentioning The Finwikian! 🙂

    It’s great that your retirement is vested immediately. One less thing to worry about.

    I think in the long run cash isn’t a good idea because it automatically decreases due to inflation. But solid emergency funds are excellent.

  2. Andrew Stevens permalink
    March 4, 2008 7:30 pm

    For what it’s worth, I like your new goals regardless of whether I agree or not with Meg’s doom and gloom scenarios. Here is my own opinion on such things.

    1) Always, always, always get the full match on your 401(k). This is a no-brainer.

    2) If you qualify, always contribute the maximum to a Roth IRA. Meg seemed to suggest that people should cut this out. If that’s what she meant, I think she’s flat wrong. Roths can act as a “super emergency fund” since the contributions can be withdrawn at any time without taxes or penalties. Obviously, this should be reserved for real emergencies since you lose future earnings on that money (they don’t let you put the money back). However, it is foolish to not contribute to your Roth in order to sit on cash. If you’re concerned about market volatility and losing that “super emergency fund,” by all means put it in a money market fund or a similar safe investment. It doesn’t have to be in stocks. (You can even put it in TIPS if you’re really worried about inflation.)

    3) Contributing to the 401(k) without match is much less compelling than those first two (or to a traditional IRA if you don’t qualify for a Roth). By all means, if you can afford it, I would suggest putting as much into tax-deferred savings as you can. But I’d prefer to be sitting on a decent pile of cash before I worried too much about this. (A major exception is if I needed to shrink my AGI for tax reasons.) A $15,000 emergency fund (or more) sounds like a good idea to me before I’d be too concerned about the tax-deferred non-matched savings. Even if you decide to shrink that emergency fund later, it can be a downpayment for a downpayment when you choose to buy a home or any number of other things.

    However, it should also be said that you’re quite young. A down market is a great buying opportunity for you in stocks, so you should have some regrets for not buying more of them. I could go both ways on this one, but all in all, I think your new goals are best.

  3. March 4, 2008 7:40 pm

    I think a $15K emergency fund is good. That’s what my husband and I are are aiming for. We live in a high-cost area like you, but our risk is spread out a little since it’s unlikely we’ll lose our jobs at the same time. I’m going to try and save more short-term savings too for an extra cushion and/or car or house down payment for the future.

    Ps I have goal ADD too. I’ve changed them a lot more in my head than I have on my blog, but I’ll have to update my 2008 goals again soon.

  4. sjean permalink*
    March 4, 2008 8:04 pm

    @andrewstevens – I don’t quite agree either, but she isn’t the only one saying that. Mostly, it reminded me that my cash goal was a little lower than it should be considering new expenses. Totally agree about the 401k match and Roth, I’ve checked both those boxes and now will be focusing on cash reserves before adding non-match to 401k. cash is “boring” for me to save, but necessary

    @ms. m&p – glad to hear i’m not the only one with goal ADD. Maybe I should let them sink into my head before I go changing them on my blog. 🙂

  5. Anonymous permalink
    March 5, 2008 7:02 am

    I have a Roth 401k that I am currently funding at 10% with 6% employer match (not fully vested until 9/09) – would it make any sense for me to cut back my Roth 401k contributions to 6%, get the match, and then put the other 4% in a Roth IRA?

  6. sjean permalink*
    March 5, 2008 7:07 am

    Anon- I’m no financial advisor here, so please take any thoughts I have with a grain of salt. I also am not 100% versed in roth 401ks, as I don’t have one.

    I don’t see a good reason to do that though. Why are you considering it?

  7. Anonymous permalink
    March 5, 2008 7:23 am

    I wasn’t sure if accessibility to funds would be easier in a Roth IRA than a Roth 401k if we’re talking about using this money as a “Super Emergency Fund”…

  8. Andrew Stevens permalink
    March 5, 2008 8:09 am

    Anonymous, I’m not an expert on the Roth 401k, so you can find out from your plan sponsor if I’m wrong. My understanding is that the Roth 401k is slightly less advantageous than the Roth IRA. The Roth IRA allows you to withdraw on a tax-favored basis. So you get to withdraw all of your contributions before you have to withdraw any of your earnings (and pay taxes on them). My understanding is that the Roth 401k isn’t as generous and withdrawals are treated like they are in regular 401k’s (except that you don’t have to pay taxes on the contributions). So if you had an account with 90% contributions and 10% earnings, you’d pay taxes on 10% of your withdrawals (and possibly penalties on the whole thing?). The reason for this, I believe, is so that people don’t put money in just to get the employer match and then immediately withdraw it without consequence.

    So, yes, I do think the Roth IRA should take precedence over a Roth 401k without match.

  9. sjean permalink*
    March 5, 2008 8:11 am

    Thanks Andrew! That makes sense.

  10. March 5, 2008 8:52 am

    So what makes sense? Maxing out my Roth IRA or putting more money towards my EF? Sadly there isn’t a lot of room in my budget to save more without taking away money from my Roth IRA. Though, by the sounds of it I should be trying to save more cash.

  11. March 5, 2008 8:52 am

    Btw, Stacking Pennies, Thank you so much for telling me about grad cafe. I went on and found out that another person who applied to the same program and for the same degree hasn’t received anything either. I’m still anxious but it makes me feel better. Thanks again!

  12. Andrew Stevens permalink
    March 5, 2008 9:26 am

    My opinion is max out the Roth IRA, even if you have to drain the emergency fund to do it. However, two points. 1) Don’t bother putting in money that you know you’re going to need. 2) If you’re nervous about investing money which is “doubling” as an emergency fund (while you restock your emergency fund and save up for next year’s Roth), put it in something conservative. Most places you can put a Roth IRA will have a money market fund or something similar.

    A Roth IRA, invested conservatively, is as good as cash for emergencies and, more importantly, is still a Roth IRA if that emergency never comes.

  13. sjean permalink*
    March 5, 2008 10:25 am

    @asgreen – glad to help with grad cafe–misery loves company! 🙂

    I guess, doom and gloom aside, people need to think about how much cash they are comfortable having in their efund and how much of a priority it is to them. If you are ok with your current stash, then no need to change anything.

    I do agree with Andrew Stevens–a Roth can be as good as an efund.

  14. Andrew Stevens permalink
    March 5, 2008 10:40 am

    I also want to stress (in case I haven’t) that ideally you should be maxing out your Roth and have a well-stocked emergency fund. My advice for draining your emergency fund to max out your Roth is only if you are (hopefully temporarily) in the position of being able to do either one or the other, but not both.

    I believe the Roth IRAs are such a good deal (investing for the future, but also preserving flexibility for catastrophic events) that everyone who is eligible to max them should do so. If you can’t afford it, you should figure out a way to earn more or spend less so that you can. Only getting the full match on your 401k is a more important saving goal.

    Draining your emergency fund to fund a Roth has another psychological advantage as well. I think most people will think harder before pulling money out of a Roth than they will from a normal emergency fund. Anything that gets you thinking of an emergency fund as only for emergencies (and not for a new car or computer) is a good thing.

  15. March 6, 2008 9:26 pm

    I agree about maxing a Roth IRA if you possibly can, even if it means short changing your EF for a bit. The reason is that you can always withdraw Roth IRA contributions penalty and tax free if you choose to (since you already paid taxes on your contributions). You can’t withdraw any earnings (dividends/interest/capital gains) without paying taxes and penalties though (unless it’s for a house, education, or hardship withdrawal).

    So in reality, you could deplete your EF to max out your Roth and still technically have an EF – you can even put your Roth contributions in cash if you fear you actually might need/want to withdraw them in the short term. It’s better to get the money in there and maybe have to take it out than to miss out on the opportunity to contribute in any given year.

    PS – Roth IRAs are also more beneficial than Roth 401ks because 1) you can invest in literally almost anything you want, 2) you don’t have to take required distributions at 70 1/2, and 3) you can leave it to your kids and they can inherit it without having to pay taxes on it – and they don’t have to take distributions either. Not the same with 401ks.

    PPS – I’m not TOTALLY doom and gloom! I just occasionally remember the probability that difficult financial times will plague our generation at some point (as they haven’t yet), so I think I should probably be slightly less aggressive than I’m otherwise inclined to be.

    Thanks for the links!


  1. Fast and steady « Stacking Pennies

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