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On Emergency Funds
In my first Suze Orman commentary, I remark "The first rule is to protect yourself from ruin. To have enough in the bank for emergencies." This was in response to Suze suggesting that a woman use her $7,000 savings account to pay off a $7,000 car loan. Now, in the real world, when a planner sits down with a client, I'd expect to find out how much this woman has in other assets and debt.

Any dialog regarding emergency funds can only be answered intelligently with much supporting information. An overall view of the person's savings and debt is a good start.

One owing money on credit cards at, say 20% shouldn't sleep better for having $2000 in the bank earning 5%. This differs from the case above in that the woman with the car loan at 6% but earning 5% in the bank would be paying $70/yr at the start to maintain her savings. If she paid the loan back and then needed to raise money, where would it come from? It doesn't take too many months to save enough on interest (at 20%) to fund a cash advance if needed later on. Paying down the cards using one's emergency money also should be a first step towards financial solvency, not an excuse to charge the cards back up.

Another example: Someone who just makes ends meet, with a few thousand in the bank, but isn't putting money into their (matching) 401(k). In the 28% bracket, you can put $4166 into the 401(k) account and be out of pocket $3000. Say the employer matches 50% (some match 100% of the first 3-6% deposited), after the match, you'd have $6250, double the $3,000 from the emergency fund. 50% (up to $50K) of a 401(k) may be borrowed at a low interest rate (now, about 8%) and paid over 5 years. The $3,000 may be borrowed out at a cost of $60/month.

At the higher end of the income scale, one may have access to a 401(k) loan and an equity line to smooth out any short term bumps in the road. In the short term, if 3-6 months of expenses are what you need to sleep at night, then by all means, stick with that. But consider the opportunity cost involved. Perhaps much of that money is better invested in stocks for the longer term.

JOE