Financial guru Suzie Orman loves her some emergency fund. She’s gone as far as advocating paying the minimum on your credit card in order to build an eight-month emergency fund. Nothing like letting a mountain of debt accumulate at 15% in order to stash away cash earning 1%. I’m all for liquidity, but at some point, common sense has to prevail. Plus, those with credit card debt in the first place have already demonstrated an inability to spend within their means. What are those people going to do with a mountain of cash at their disposal?
Advocating such a bloated emergency fund tricks people into putting more cash in low earning bank accounts than they need. There’s no reason to keep such a large amount of cash on the sidelines, doing next to nothing, just because it has an arbitrary label assigned to it. Savings is savings. If you get into a bind, are you only going to access the cash labeled as Emergency Fund? Of course not. You’re going to tap into the funds available to you as you need it.
An eight-month supply of bare essential expenses for my family is about $22,000. My online savings account at Ally Bank earns 1%. In 2016, my after-tax investment portfolio earned around 10%. Had I designated $22,000 of my after-tax savings to only be used in case of emergency, that would have cost me around $2,000. Over a ten year period, this would cost me over $40,000 assuming a 7% return (average of the S&P with dividends over past 10 years) compared to a 1% return on a money market account.
Now, I’m not advocating keeping zero cash on hand to pay for unexpected expenses. I keep a small amount in a money market account that is separate from dedicated savings for vacations, home projects, etc. Here’s a look at our funding sources available to us without penalty in case we get in a bind.
- Money market account $4,000
- Liquid after-tax investment accounts $30,000
- Line of credit at 3.5% interest with limit of $20,000
- Untapped home equity $80,000
- Roth contributions $68,000
By taking a bigger view of my financial situation, I know I have $200,000 in funds readily available if I need them. There’s no need to keep a substantial amount of money on the sidelines earning next to nothing. As I continue on my path towards FIRE, my after-tax investment accounts will continue to grow, providing more and more security.
Keep Your Money Working Hard For You
Compound interest is a powerful force. Warren Buffett calls it the 8th wonder of the world. In order to take full advantage, you need to but those dollars to work. Don’t discriminate against a large portion of your savings by not allowing it to reach its full potential. Even if you’re not actively seeking FIRE, you should have an after-tax investment portfolio to provide some flexibility. These dollars work hard for you day and night to reach their full potential. They can be accessed at any time to fund a variety of needs, including emergencies.
And what if that long awaited market correction comes? Well, if the market drops by 30%, I’ll still have $21,000 in liquid after-tax investments, plus the $4,000 in cash, plus another $168,000 in other sources. Even without home equity and another line to tap, and assuming I don’t want to touch my Roth dollars, I would still have $25,000 to access. Enough to get us through about nine months during a recession.
Even if you’re an uber conservative investor, there are many other options available that earn more than a money market account. Five-year CDs, a great option for building a CD ladder, have rates as high as 2.3%. Treasury Series I savings bonds pay an annual rate of 2.76%. Sure, you’ll pay a penalty in the event you need to access these funds early. This amounts to three months of interest on an I-bond if you withdraw before five years and typically six months interest on a five-year CD. But you’ll come out ahead of the measly 1% from a money market fund.
Readers, what funding sources will you tap in case of emergency? Are your after-tax dollars being maxed to their full potential? What are your thoughts on the uber conservative TV finance stars like Suzie Orman? Share your thoughts in the comments below.