There is a ‘rule of thumb’ out there that one should save 3-6 months salary (net, I assume) and from the near 16,000 Google returns on “emergency fund” “rule of thumb”, it would seem this is a hot topic among financial concerns. At Master Your Card, Kristy on Monday discussed the importance of the emergency fund, and while I agree with her that you shouldn’t put those funds into stocks, which may or may not be down at the very time you need the funds, I am concerned about the priority most attribute to the fund.
You see, most financial rules, are just that, generalizations that may apply to many/most of the readers of such advice. It’s easy, however, to offer examples where the rule(s) need some modification once the rest of the situation is understood.
For emergency funds, first, does your company have, and do they provide any matching contributions, to a 401(k)? If so, this is my highest priority. Some companies match as much as the first 6% of an employees’ salary deposited into their 401(k). On $50,000/yr, that’s $3,000 the company will match against your $3,000 deposit. In the 25% tax bracket, your net cost is only $2,250. Let me spell this out carefully – you are out of pocket $2,250, but now have $6000 in your 401(k)! Do you see why this is my top priority? Should you fund an emergency fund first, or take $2,250 and turn it into $6,000? If you lost your job, and had to take it out next year, you will likely drop to the 15% bracket, and after the 10% penalty for withdrawal, you still take out $4500. A side benefit, also subject to dispute, is that with $6,000 in the 401(k), you now have the ability to borrow $3000 back out, at 7-8%, and use that loan to knock down the high interest credit card debt. Yes, there are those who advise against the 401(k) loan, but in this scenario, it can be part of a kick start to both your retirement savings and debt reduction plan.
From a completely different perspective is an article on MSN titled “The $0 emergency fund“. I think that may be taking it a bit too far. (The link is currently broken, MSN redecorating, it seems)