Smart or Stupid? My Emergency Fund Approach

I’ve outlined my emergency fund approach to a few people and some have called me reckless and foolish. Others have said it is a wise financial decision demonstrating a knowledgeable level of prudence.

I’ll outline my approach here: when it’s smart to have an emergency fund and when it’s smart to reduce the level of that cash buffer. Now I’m curious to see how my readers will weigh in on the, “Are you an idiot?”, debate.

Before we dig in, let me clarify one point: we should all seek to have an emergency fund. Ideally, at least 3-6 months worth of monthly expenses.

I prefer to think of an emergency fund for WHEN we need it, not IF we need it.

We can’t use an emergency fund wisely or foolishly, if we don’t have one to begin with.

A successful buddy of mine in banking said he didn’t need any sort of cash buffer because he had a steady paying job and various types of insurance to cover any type of problem that could come up.

Then one day he stumbled into legal trouble and racked up a four figure legal bill, overnight.

He has since reformed his ways.

We would all agree an emergency fund is used wisely when we come against an actual emergency. There is no controversy in that. The few cases I can think of off the top of my head include a major non-routine repair on a vehicle, a medical emergency, or if we have high interest on credit card debt.

There isn’t much reason to holding cash at ~0% interest if we’re racking up 18-24% interest on credit card debt. Afterall, if we pay down the credit card debt and need to pay for that major car repair, we can charge it on that credit card and be back to square one.

Here’s my emergency fund approach: my girlfriend and I recently came up against the 2015 deadline for maxing our IRA contributions.

We both decided to draw down on our emergency fund to meet the maximum contribution levels.

Our total withdrawal took us from having ~4 months worth of saved expenses (rent & student loans), to only having ~2 months worth.

If we factor in our monthly budget outside of rent & student loans, then the numbers look closer to be as ~2 months to ~1 month’s worth. These numbers are on the conservative side because I would imagine our monthly budget for wine or dining out would be cut if we faced a situation where our incomes dried up.

The risks at play here are clear: If one of us loses our job, we would immediately need to stop all contributions into our 2016 retirement accounts. If we both lost our jobs, then we would rack up credit card debt and we would only have 2 months for at least one of us to land a new job.

We both are covered by insurance, including renters insurance.

I’m not advocating having no cash buffer or not trying to build up an emergency fund. I’m advocating using an emergency fund when we can see a meaningful reward and we can identify the risks at play.

In our case, the IRA contributions saved my girlfriend $1,581.35 on her 2015 tax bill. The payments directly associated with our cash buffer drawdown accounted for nearly 75% of that savings.

First off, this process has obviously involved some stress. My girlfriend does not enjoy seeing our combined cash balances so low. But, the level of stress does not outweigh our combined desire to max out our IRA contributions.

We prefer to think we have no other option.

It makes sense to us, that in order to build wealth in a meaningful way, there would need to be some risks involved.

If it was an easy process, then more people would be financially independent. We do believe it is a simple process, but far from easy.

As for finding a new job, I have a high level of confidence that we would not be unemployed for two full months. My confidence is based on our experiences when we had to find new jobs. I’m also confident, worst case scenario, that my former employer would be more than happy to take me back if somehow my current employer let me go.

They say ‘job security’ is not about how secure our current job is, but how quickly we can find a new one if needed.

With everything considered, how do you view my emergency fund approach?

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Have you done anything similar with your emergency fund in recent years? Do you stick to having at least 3-6 months and never touch it unless it is an absolute emergency?

Master Distiller

40 comments… add one
  • The Green Swan Apr 19, 2016, 6:31 am

    I voted other…I think you are fine with 2 months cash balance. I personally only have about 1 month. Things have come up like unexpected medical bills and car repairs, we put it on the credit card which gives us a month or so until the bill comes and by that time we would have made another couple paychecks and we can pay it off entirely still. So I see no problem handling those types of expenses.

    Then, if we had a major crisis where one or both of us lost our jobs for a prolonged period, we have our taxable brokerage account which we could always access. Another option for people would be to access their contributions from their IRA account (although this is not ideal because you can re-contribute those funds later when you have the money again). But we basically rely on our taxable brokerage account and we’ve actually never had to access it before.

    Good call on putting the money in the IRA. Maybe reconsider having 3-6 months in cash earning 0% and put some at work in a taxable brokerage account?

    The Green Swan

    • Distilled Dollar Apr 19, 2016, 6:47 am

      After we max out our pre-tax accounts, our next step is to increase our cash buffer. This is actually happening this year, barring any major changes.

      The main reason is we’re starting to save now for a downpayment on a condo.

      If we weren’t in the market to purchase property, then the money would be going into taxable accounts, likely via Vanguard index funds.

  • Dividendsdownunder Apr 19, 2016, 6:46 am

    Hey, nice thought process.

    I think your approach was well considered and it saved you money in the long run. As long as you plan to build up your cash again then it’s all good. I recently did a post our our emergency fund thoughts (plug lol).

    At the moment we have 3 month’s expenses emergency fund, plus 1 month of expenses in our transaction account. We also have cash building in a long term goal account but pretty much all of that is being used make an IVF baby at the moment.


    • Distilled Dollar Apr 21, 2016, 6:36 pm

      Thanks for the reply Tristan. My big takeaway after writing this post is realizing just how different emergency funds can be for different people.

      We plan on building up the fund again as soon as we can. My girlfriend essentially went from having no cash buffer in the past ~5 years to having one for the first time recently, so she’s eager to get back to at least that ~3 month cash buffer.

  • Apathy Ends Apr 19, 2016, 7:48 am

    We have about 2 months stashed away in a “high” interest online savings account (1%).

    I think 6 months is a lot to have sitting for people with stable jobs and employable skills (if something does happen).

    I wrote about emergency funds awhile back and my thought process around them – factoring in children, job stability, insurance deductibles etc.

    at the end of the day it’s all about what you are comfortable with. If you decided to pull the money out for front row Hawks tickets I may have a different opinion

    • Distilled Dollar Apr 21, 2016, 7:32 pm

      Front row Hawks tickets does sound amazing!

      “at the end of the day it’s all about what you are comfortable with.” – Couldn’t agree more

      This reminds me of the short story about the guy who’s stressed about his money in the stock market so he asks his broker what he should do, to which the stock broker says, “sell until you can sleep soundly.”

  • Kate Apr 19, 2016, 8:27 am

    I think an emergency fund evolves over time. I used to have a lot of cash on hand, knowing what can go wrong with my house, car, etc. But now that I have a sizable amount of money in my taxable brokerage account (which is mainly earmarked for early retirement), I have much less cash. It’s really just enough to cover the house and car deductibles and replace a few appliances should they break. My HSA has enough to cover my medical annual out of pocket.

    Everyone has different financial needs and various comfort levels. Your emergency fund is there to help you sleep better at night so whatever amount and combinations of accounts does that is entirely up to you. Definitely not a one-size-fits-all kind of thing.

    • Distilled Dollar Apr 21, 2016, 7:48 pm

      That’s a great point about having some liquid assets in a taxable brokerage account. If you’re comfortable with the risks of needing the money during a short down tick in the market, then its the right path for you. As you put it, not a one size fits all type of thing.

  • FinanceSuperhero Apr 19, 2016, 9:30 am

    Your emergency fund plan seems very sensible to me. I gather that you are in a position to be very flexible, financially speaking, and increase your emergency fund in a hurry if you needed to do so. I also feel that betting on yourself, as long as it is not done in a reckless manner, increases your sense of urgency to adhere to your goals and stay focused.

    Currently, my wife and I maintain 3-4 months of what we call “scorched earth” living expenses. The funds would cover our mortgage payment, basic food, and basic utilities. We are going to reduce this figure to 1 month of funds soon because we are inching closer to being able to completely pay off our non-mortgage debt. We feel comfortable doing so because our 9-5 jobs are extremely stable and our self-employment/1099 income is projected to increase significantly in the next 3 months.

    I like to ask the question, “Would you go out and borrow money on (credit cards/student loans/whatever the debt is) to increase the size of your non-interest bearing emergency fund?” I still haven’t thought of a scenario in which the answer is “yes.”

    • Stefan @Mllnnlbudget Apr 19, 2016, 4:37 pm

      If I may help answer this question, I would never borrow funds for a non-interest bearing fund with interest bearing instruments. If you need the funds badly then you should be taking out a loan but I see no reason why you should have to take out a loan to fund a non-interest bearing loan. You are essentially losing money to interest as I am sure your scenarios keep coming up with.

    • Distilled Dollar Apr 21, 2016, 7:55 pm

      I like the term, “scorched earth”! I usually use “spartan lifestyle,” but I might need to switch it up.

      I agree with your answer, that I wouldn’t opt to borrow money in that case.

      Also, props to you as it sounds like you’re diversifying your income! That’s another way to make sure your cash buffer is less likely to be used.

  • Scott Apr 19, 2016, 12:39 pm

    You weighed the risks of withdrawing from your emergency fund for something that isn’t an emergency and made that choice. I can see how you wouldn’t necessarily want to plan to top off your IRA every year with your “emergency” fund, because that sort of defeats the purpose of the emergency fund. I’ll offer a similar option, though, which is you could top off a Roth IRA with no loss of liquidity. Since you can withdraw your Roth contributions at any point penalty free, you could ostensibly have the best of both worlds: investing at the highest amount possible while still having access to that money in the event of an emergency. What you miss out there, of course, is the tax break. But it’s a consideration for those who don’t feel comfortable locking up their emergency fund in an illiquid (at least without facing a penalty) asset but loathe having so much cash sitting in even a .75% or 1% high-yield online account.

    On another note, just found your site through Rockstar Finance and liking what I’ve read so far. I hope to dig into it more as time allows!

    • Distilled Dollar Apr 21, 2016, 8:16 pm

      You bring up a great point with the Roth IRA contribution! I’ve focused solely on the Traditional IRA as I plan on using an IRA conversion ladder as part of my early retirement strategy.

      One thing I overlooked was that I originally started with a Roth IRA as my investment strategy. Technically my cash buffer COULD include this amount — even though I have earmarked it for retirement. Your comment reminded me that I can pull out those contributions at any point tax free and penalty free. Thanks!

  • Stefan @Mllnnlbudget Apr 19, 2016, 4:35 pm

    I voted that this was a sensible plan. I think that your goal of maxing out your contribution levels is a smart call as you both have jobs that seem to be very flexible so two months makes sense. Knowing that you are a CPA with Big 4 experience, it will be fairly easy to find a job (honestly you won’t be unemployed for more than a month unless you did something wrong in your job). You do not have a mortgage either which means your debt is fairly limited to loans, credit cards etc. Emergency funds are intended to cover monthly expenses not a catastrophe (eg. house burns down) so I think you are making the right call.
    I would add that Scott’s point is very valid with the Roth IRA even though you are reducing your taxes. As I am sure you know, Roth IRAs are very beneficial to people who are now starting their careers and are lower in the tax brackets. As you climb the brackets the debate is clearer.

    • Distilled Dollar Apr 21, 2016, 8:34 pm

      The Roth IRA strategy is an interesting one, but I’m not convinced it is the right move for those seeking early retirement and financial independence at an early age. If someone plans on continuing to earn the same level of income and even higher levels of income throughout their 50s, 60s+, then I can see why a Roth IRA makes sense.

      I’ve actually started putting together a post on efficient tax strategies for an early retiree. The Roth IRA vs Traditional IRA question is definitely a large component of what makes sense, and it isn’t a one size fits all situation.

  • Financial Slacker Apr 19, 2016, 7:51 pm

    Your approach sounds fine to me. I wouldn’t think that there is a strong chance that both you and your girlfriend would be out of work at the same time.

    For me, having multiple income streams is the key. And you have that with the two of you working.

    • Distilled Dollar Apr 21, 2016, 8:46 pm

      Agreed, a small chance, and one we’ve accepted as part of the risk associated with the strategy. Having dual incomes helps a tremendous amount as I mentioned in the post. If one of us loses our job, we’re still on a relatively strong financial footing until another job is found.

  • amber tree Apr 20, 2016, 3:23 pm

    It makes sense to me. You used the funds to create extra income (tax refund) down the road.
    –> They say ‘job security’ is not about how secure our current job is, but how quickly we can find a new one if needed. <–

    This adds a new angle to the equation for me… A lot to think about.

    I have a post ready on using the emergency fund/life happens fund to lower the mortgage. It is the same thinking: will we have enough cash in the worst case of both loosing our ob or being in an accident or alike?

    • Distilled Dollar Apr 21, 2016, 8:59 pm

      I always liked that job security quote and it made a lot of sense. People tend to discount the worst case scenario, but sometimes it does happen.

      If you live and work for 40 years, you’re bound to be hit with a few ‘once in a decade’ situations, either career wise or in our personal lives.

  • Isabel Apr 20, 2016, 7:45 pm

    I voted for you smart! If I did something like that I think it would be foolish! Age, circumstances and where one lives come into consideration! I am comfortable with an emergency fund, no loans and in credit with utilities etc. I am well aware that no matter how large the emergency fund the emergency may be bigger! Love reading your column!

    • Distilled Dollar Apr 21, 2016, 9:00 pm

      Thank you Isabel! That has also been one of my key takeaways after reading this post, is seeing the variety of different approaches to an emergency fund. As you put it, it all comes down to what makes us comfortable.

  • I voted for the other. My approach for emergency fund is something different or off based on some people’s standard. I keep around a year’s worth of emergency fund. May be I do this because I’ve been in situations before when I didn’t have a job or lost a business and racked up a lot of debt in the process. I don’t ever want to be in that position.

    Even though I saved 1-year of emergency fund, I do invest as well. I make sure that I balance both. I only saved 1-year because I’m the only right now who’s working in my family. My wife stays home and takes care of the baby. In the event that I get laid off, I know I still have some buffer in the event that I can’t find a job within three months.

    • Distilled Dollar Apr 21, 2016, 9:05 pm

      In a one income house, I would probably copy your approach as well.

      Do you feel benefits at your current job knowing you have a full one year cushion?

      If it was me, I feel like I would be able to do a better job. It would also help that I didn’t NEED that next paycheck, and could focus on my daily/weekly tasks.

      Since our cash buffer is on such a short timeline, I feel like this is one concern that does pop into my mind at least once or twice a week. That is probably the number one motivator for me to get our cash buffer back up.

  • Dames in Debt Apr 21, 2016, 9:49 pm

    Makes perfect sense to me! As someone paying down a lot of high-interest debt, my emergency fund is for true emergencies, and therefore, is only a specific amount of cash (my insurance deductible x 2 to be exact). Ideally, I’ll have more in the future, but for now, credit card payments are king.

    I think maxing out the IRA (with an added tax return bonus) was very smart. I’m sure you guys will have a robust emergency fund soon!

    • Distilled Dollar Apr 22, 2016, 6:33 pm

      Sounds like a good plan to me as well.

      As for our cash buffer, we just received our latest paychecks and it looks like our cash buffer will only continue to grow from here (fingers crossed).

  • Martin - Get FIRE'd asap Apr 22, 2016, 7:00 pm

    Hey there Matt, I think that the definitive answer to this is, there is no definitive answer. Every case is different depending on how quickly you may need to get your hands on cash, how your investment portfolio is structured, how easily tempted you may be by ‘cash in the bank’ and so on. If your strategy works for you then that is the right one in your case and no one can tell you it’s wrong or stupid. And it will evolve and change over time as your circumstances change. I hold only around $1,000 in cash with the rest squirreled away in various investments both liquid and no-liquid. If an emergency occurred, and my $1,000 wasn’t enough, then use the credit card for the short term fix. Then I can withdraw funds (reluctantly) from one of my more liquid investments. So far, I haven’t had to do this but that’s my plan at the moment. Touch wood, I’ll never have to test it out.

    • Distilled Dollar Apr 22, 2016, 7:28 pm

      That’s a great point and something I’ve learned throughout this post and reading the follow up comments/messages.

      While some guidelines are provided in personal finance and most people would agree with adhering to them most of the time…there are still exceptions to every case.

  • Mr. PIE Apr 23, 2016, 5:39 am

    As we got older our emergency fund got smaller. We had been very conservative at advice of a former advisor. It is now half of what it used to be and still covers 6 months of expenses.
    In retirement there are good arguments for having enough to covet the time a bear market takes to recover rather than drawing down stock or bond investments. As you say, every situation is different and that’s ok.

    • Distilled Dollar Apr 27, 2016, 8:22 am

      6 months sounds like plenty to me, unless you have risky sources of income, of course.

      You make a great point about having cash on hand when an opportunity (such as a bear market) comes up.

  • Lisa Apr 25, 2016, 6:12 pm

    Here’s my two cents – I don’t think this is a dumb move at all. As long as you still have some in cash, you’re all good. The most important part is that you’re aware of all the risks involved and you made this decision as informed as possible. I would think this was a “stupid” decision if you didn’t think about the risks at all.

  • Todd Guthrie Apr 28, 2016, 5:20 pm

    First of all, great topic. There is a lot that could be written about emergency savings. For example, some people think of a typical 30,000 mile-maintenance, or big IRS bill due to under-withholding, as an unexpected “emergency” simply because they failed to plan for it. I think it’s pretty straightforward to plan and budget for relatively predictable recurring expenses like car maintenance, dental work, and property taxes, but I find most other people simply don’t.
    In that sense, someone who is good at financial planning might not need as much liquid assets as someone else who is not.

    Here’s a question for you: what do you think about using the available balance of a home equity line of credit, in place of an emergency savings account.
    I have a line of credit against my home equity, which I can borrow at any time for about 4% interest.
    That means if something bad comes up (car repair, legal bill, medical bill, loss of job), I can borrow a large amount of money at a relatively low rate until I can get back to even.
    The risk of course is that the bank could arbitrarily lower or remove the line if they find that my means have decreased (such as due to loss of job), or if the equity in my houses goes below threshold. In fact, I hear that many banks did exactly that to some borrowers during the Great Recession.
    So the risk is there, but I think it’s outweighed by the benefit of not having to sit on tens of thousands in cash.
    What do you think?

    • Distilled Dollar Apr 28, 2016, 9:58 pm

      Hi Todd, thanks for the comment! For a HELOC, I suppose I would need to know a bit more about the details.

      You mentioned you can withdrawal at any time, but is it a one time withdrawal on equity? How would it impact your credit? If your credit is affected, then are you looking to buy more real estate or are you in a situation where you might need a good credit score?

      It sounds like you are aware of the risks at play and may have already decided to take on the risk. If you are choosing to take on the extra risk, I would just ask if you’re 100% okay with facing the risk. In my case, I knew we could cut our current spending level to offset most of the risk at play. It wouldn’t be much of a lifestyle downgrade since it would only be temporary. If your line of credit was rapidly reduced, could you increase your savings rate to close the gap?

  • Pamela May 18, 2016, 1:31 am

    My husband just ran a somewhat risky investment idea that we will be implementing in Jan 2017. I will provide more detail about it on my blog in future months but the gist of it goes that we will take out $20k of unsecured loc loan paying interest only and invest the money using the dogs of the dow strategy. We will then use he divident income/capital gain to pay down the interest expense and reinvest the rest. Its will also make for a nice tax write off. I am only comfortable in doing this because I how he knows what he is doing. He not only does this for a living for other people, but he does alot of research and understands technical analysis.
    I think taking risk is good if its calculated risk. We have $0 debt, $10k in emergency savings plus another $10k in planned spending like a baby fund and vacation fund and of course our retirement accounts & tax free savins accounts. We feel comfortable taking on this risk and it seems based on your analysis of your situation you feel the same for yourselved. best of luck.

    • Distilled Dollar May 19, 2016, 11:25 pm

      That sounds like an interesting strategy. Taking out 20k, and then paying back the interest with dividends and counting on capital gains to make it a profitable venture.

      You summed it up perfectly. You have evaluated the risks, assessed your current situation and you’re making a choice with the information at hand. What I can’t stand is when people take a gamble without knowing the risks/rewards.

  • Julie@ChooseBetterLife Jul 12, 2016, 9:51 am

    It sounds like this was a great experience for you guys to really decide what’s most important to you. If investing is important AND you feel a little nervous with a smaller emergency fund, then next year you’ll be sure to plan ahead to invest without having to drain your EF.

    • Distilled Dollar Jul 21, 2016, 6:25 am

      That’s a great point Julie. These past few months I’ve been focusing on avoiding the same scenario during the early months of 2017. I’m happy to say I’m on track and it feels good that the future stress will not be there.

  • Seeking the Dividends Jul 14, 2016, 2:32 pm

    Wow this is eerily similar to what I did this past April. I went from 4 month EF to a 3 month EF to meet my Roth IRA max contribution. I think it depends on how quickly you expect to replenish what you’re transferring to your IRA. In a few months, I was able to replenish it back to 4 months.

    After April, my goal is to max out my Roth IRA before the end of the calendar year.

    • Distilled Dollar Jul 21, 2016, 6:43 am

      Sounds like we both had a similar learning experience this year! Hah.

      I’m also hoping to be able to avoid the same turmoil next time around. So far, I’m on track. 🙂

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