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Emergency Funds

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)

  • Dave Shafer June 13, 2008, 10:54 am

    The problem is when you are trying to speak to a wide audience, much gets lost in translation. For a financially stable audience with investments and home equity, it is really only a question of access to money. For folks who are less financially stable then the equation changes. You can’t get a HELOC if you have no equity, or you don’t own a home. You can’t use credit cards that have low limits on them for long. And if you 401K has only a few thousand in it, it won’t last you long. For those folks, saving money in a low risk environment is both a must and a good habit.

  • JOE June 13, 2008, 1:19 pm

    Dave – again, thanks for writing. Agreed, regarding ‘lost in translation’. The advice I offer here can’t be the exact advice I give with each and every individual I sit with. There’s always the bell curve, some who will blow up at the first emergency at one end, and others who can load up their 401(k) the first year out of school, to be able to access half of it if need be.

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