An emergency fund can be a vital part of your overall economic and personal finance plan. While I don’t believe in having a large part of your net worth in cash that sits in a bank account, an unforeseen accident or emergency can produce an immediate need for cash. During times of distress cash is King. An emergency fund is basically cash set aside to pay for emergency expenses.
I’m currently in “accumulation mode”. What I mean by that is that I’m currently accumulating assets that will pay me to own them. Hopefully these assets will fund my early retirement. Because of that, cash really does me little good. Cash in large amounts while I’m trying to accumulate equities provides an opportunity more than anything else. At this current time I think of having large amounts of cash as an opportunity to jump on stocks when the market prices them at discounts to their true value. During these times of extremely low interest rates, having lots of money in the bank is counterproductive, as inflation will erode your purchasing power over time.
At this time, because I am in accumulation mode, It would be ideal to keep 4-6 months worth of expenses in cash. I like to think of emergency funds in terms of percentages of your expenses, instead of absolute dollar amounts. Cash is just one part of my emergency fund, the family currently has $10,000+ in a revolving credit line available to us should a large emergency ever present itself. There are few things these days you can’t purchase with a credit card, so this would be a last resort. Of course, we could also sell equities if something truly catastrophic were to happen to us.
An Emergency Fund Should Be Tailored
While I feel the numbers I’m presenting to you today work for me, I think an emergency fund is something that should be uniquely tailored to one’s own situation. Some questions should include:
* Do you have children?
* Do you own your own home?
* What kind of insurances do you have?
* Do you have elderly family members that you may be responsible for?
* What are your monthly expenses?
* What kind of cash flow do you have?
* Do you have a large number of liabilities? Are you drowning in debt?
* How secure is your employment?
Be Honest With Yourself
These kinds of questions will give you a strong idea as to what kind of emergency fund is appropriate for you. I think if you own your own home you should definitely have extra money set aside for household repairs and improvements. A small emergency could be taken care of by the large buffer that someone has between income and expenses and thus save the difference.
I go back and forth with my wife about how just about anybody can save money, in the end they are just irresponsible and their mindset is not in the right place. In the 21st century anybody can save & invest it doesn’t matter if its $10 or $1000 every week or month, people just choose to be consumers and just seem to spend every dollar that they make. In the end its about being honest with yourself and making the right decisions.
Once You Retire
Once I hit our ultimate goal of financial freedom between 40 and 50, I’ll be saying goodbye to the 9-5 and saying hello to sleeping in, traveling and spending more time with loved ones. Once we become financially independent and decide to part ways with full-time employment, my buffer between income and expenses will likely be gone. This amount will likely change as we get older. I believe in increasing a cash buffer as you get older due to any random things that may happen in our life as we all know.
It would also be nice, in my opinion, to have some money in the bank to fund things like a vacation or an outing that you don’t usually plan on. Once you’re no longer working it may be easier to find things that seem exciting that fall outside the usual budget. These things should be limited, however.
Work Hard or Work Smart?