Everything You Ever Wanted to Know About Emergency Funds

An emergency fund is a personal thing; each person approaches the topic in a way that best suits their situation. Several personal finance bloggers teamed up to answer the following reader question, each with their own point of view:

Is there such thing as saving too much money in an emergency fund? What’s the best place to keep the money you do save so it still earns you something while just sitting there?

The three posts listed below contain answers to this question from Lazy Man & Money, Binary Dollar, Money Matter, & More, The Digerati Life, and Suns Financial Diary. Following the article links I’ve summarized some key points made by the writers and from reader comments:

– Money Question – Can You Save Too Much in an Emergency Fund?
– Can You Be Too Conservative with Your Emergency Fund?
– Emergency Fund Investment Options

Start Saving
Many people have no emergency fund at all. If you have one, you’re on the right track. If not, start saving up and you too can have some peace of mind.

Liquidity
An emergency fund should be easily available. The assets should be liquid and the more you depend on it, the lower the investment risk should be.

Savings Amount
The recommendations for how much money you need to save in your emergency fund range from 3 to 6 to 9 months of living expenses, with one person attempting to save 18 months worth. A good minimum is 3 months; then depending on your situation and comfort with risk you can save more from there.

Living Costs
Consider whether your living costs will likely increase or decrease during an emergency period to help you plan the amount you’ll need.

Insurance
Insurance can be viewed as part of your emergency strategy. A mixture of short or long term disability, auto, home, health, and liability insurance can help offset your risk levels and the amount you need to save in an emergency fund.

Investment Options
The different options that were discussed for where to keep your emergency fund money are a money market fund, your checking account, a high-yield online savings account, and 4 week Treasury Bills.

One other choice for homeowners that are less risk averse is to put your money in a less liquid investment and open a home equity line of credit. You can tap the line of credit immediately if needed then liquidate your investments over time to pay back the money borrowed form home equity.

You can also consider spreading your money over a spectrum of financial vehicles that become less liquid and carry higher returns as you move down the spectrum. For example, have 1 months cash in your checking account, 1 month in a high-yield online savings account, 1 month in 4 week Treasury Bills, then another 3 months in a CD.

Passive Income
When you’re calculating how much to save be sure to consider any passive income you have coming in, which might offset the total amount you need in your fund.

Emergency Fund Wrap Up
Emergency funds are one of those things you never really think about until you need it and then it’s too late. Hopefully, this week’s coverage of emergency funds has answered any questions you might have about emergency funds and inspired you to begin one if you haven’t already. If you have questions that weren’t addressed, let me know through my contact form and I’ll get back to you with an answer.

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Are Business Tax Deductions Worth the Risk of Being Audited?

Trent at The Simple Dollar is looking for feedback on any article of his that you had a reaction to. In return for feedback, he’s giving away 5 free personal finance books, check out the rules for entering; this is my submission to his call for feedback.

Trent recently wrote about his side businesses of a small computer consulting business and his blog in response to a reader question. I enjoyed the sections on getting started and building the business but had a question for him on his final section about taxes. Trent wrote:

I save every receipt and full documentation on everything associated with the businesses and I don’t try to play any games with questionable deductions because it’s worth the extra taxes I might pay to avoid a detailed audit.

What are Questionable Deductions?
I’m curious if Trent could expand on what he sees as questionable deductions. The reason I ask is that I’m in the early stages of my first business and have been spending a lot of time learning about tax deductions for businesses.

The government offers legitimate tax deduction to businesses to help drive the engine of economic growth and many businesses take many thousands of dollars of deductions every year. My thoughts were that some people didn’t take advantage of these tax breaks because they didn’t understand the rules and didn’t want to risk breaking them.

I’d like to know more about the questionable deductions that Trent mentions so that I can learn more about them and avoid any mistakes he may know of.

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Emergency Fund Investment Options

Yesterday we heard from Golbguru and Silicon Valley Blogger about different factors that determine how much is enough money to keep in your emergency fund. Today Sun looks at a combination of three different options that we have for keeping our emergency fund liquid but also earning a return on our money while it sits waiting for an emergency.

Sun @ The Sun’s Financial Diary
The purpose of establishing an emergency fund is to have some money in place that is enough to cover your daily expenses when your income stops, such as lose your job. The appropriate amount of an emergency fund really depends on you spend every month on average. Multiplying the average monthly spending by the time (in months) that it will take you to find a new job will be the amount that you should set aside as en emergency fund.

There are suggestions that the emergency fund should be enough to maintain your normal life for six months, but at least 3-month worth of fund is necessary. Since the emergency fund is only supposed to be used in case of an emergency, it’s possible that one may be over-prepared by putting too much into an emergency fund. In my opinion, you don’t need a 12+-month cushion.

Money in the emergency fund should be easily accessible, meaning that you can’t use the money to make a long-term commitment such as investing in stocks or buying a long-term CD and you don’t want to put it a brick-and-mortar bank’s checking account which earns you close to nothing either. Several years ago your neighborhood bank might be your only choice, but not now. Here’s what I do with our emergency money.

1. Checking Account
I put several thousands in my local bank’s checking account so I can withdraw the money right away without any delay. If all the sudden I have a big bill to pay, in most cases I can pay it with credit cards, so I don’t have to keep a large amount of cash in my checking account. The rest of the money goes to the following:

2. High-yield Online Savings Account
There are many online banks now pay 5+% APY for your money. If you are looking for big names, Citibank (4.50% APY), HSBC (5.05% APY), ING Direct (4.50% APY), and GMAC Bank (5.10% APY) are possible choices. Some small players offer higher rates, such as Amtrust Direct ( 5.36% APY), UFB Direct (5.31% APY), and IGoBanking (5.30% APY) with low minimum deposit requirement, and they can also provide excellent customer service.

3. 4-week T-bills
This is my favorite for short-term investment that generate decent returns. Currently 4-week T-bill pays 4.939% APR, which is equivalent to 5.05% annual yield. However, since interests from T-bill investments are exempted from state and local income taxes, your actually yield will be higher (here’s a formula to calculate your equivalent yield).

From what I can see, there two drawbacks of investing in T-bill. First, T-bill rates change every week, so you don’t know in advance what you will get for your next investment (a couple of weeks ago you could earn 5.36% APY). Second, you money will be tied up for four weeks, but that’s a small price to pay for a better return, in my opinion.

Emergency Fund Overview
Check back tomorrow when we’ll summarize the input from fellow personal finance bloggers and readers on how much to have in your emergency fund and where to keep your money.

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Obsessing about Money, Cancer, Personal Development, & Family

Jeremy over at Generation X Finance shared his deep dark secrets and let the world know he’s obsessed with golf, his yard, cooking, and visitors to Generation X Finance. Now he wants to know what occupies my mind so here goes:

1) Personal Finance
I was raised to be a good steward with money and taught the basics of personal finance. Ever since then I’ve devoured books and magazines on money. I just enjoy learning about it, applying the concepts, and watching them work. I started this site to help myself learn more about money, help others learn about money, and to make some extra money. I know I’m succeeding on the first and third points and hope I’ve made some progress on the second.

2) Skin Cancer
I have a family history of skin cancer. I don’t stay awake thinking about it at night but I’m obsessive about protecting myself from the sun’s UV rays. You can ask my friends, I’ll be the only guy on the float trip or at the beach all covered up with a long sleeve shirt, a big hat, and layers of sun screen. I might look funny but I don’t care as long as I’m protecting myself.

A company named Sun Precautions makes a brand of clothing called Solumbra that is great at blocking UV ray and keeping you cool at the same time. Shopping on their website is the only time a cheap guy like me will drop $85 for a shirt.

3) Constant Improvement and Achievement
At the end of the day I don’t feel right if I didn’t learn something new and make progress on a few things on my “list”. I learn a lot from reading online and lately have taken to absorbing information via my MP3 player. It’s wonderful being able to learn about taxes from Sandy Botkin, blogging from Darren Rowse, internet marketing from Yaro Starak, and personal finance from Vanguard Podcasts all while driving to work. Of course the challenge is finding time to apply what I’ve learned in the evenings after my family goes to bed.

4) Finding Alternative Income
My poor wife, every day I have a new idea. She probably gets sick of hearing about all of them but she’s a good sport. Plus she’ll be finishing up her job in about a month to stay at home with our son so she’s open to different ways to make extra money. Right now I generate alternative income by selling on eBay and from this website. There are more sources to come; I’m still working on finding them 🙂

5) My Family
Of course the most important thing in my life is my family. I was reminded of this today as I pulled into the driveway and saw their smiling faces waiting for me. They’re a joy to be around and although sometimes it’s hard to strike a healthy work – family balance they are what keeps me going when I don’t really feel like going anywhere.

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Can You Be Too Conservative with Your Emergency Fund?

Several personal finance sites are teaming up this week to take on the topic of the emergency fund. We’re answering a reader’s question as to whether you can save too much money in an emergency fund; along with a follow up question of what’s the best place to keep the money in your emergency fund?

Yesterday, Binary Dollar discussed how most people don’t have to worry about saving too much because they don’t save enough and Lazy Man made a suggestion about how those more comfortable with risk could use a home equity line of credit for their emergency fund.

Can you be too conservative with your emergency fund? Trent from The Simple Dollar stopped by yesterday’s emergency fund answers and commented that his goal is to have 18 months worth of cash built up. As you’ll read below the Silicon Valley Blogger thinks 6 – 9 months reserve is enough, while Golbguru is a fellow believer in stashing away more cash.

Golbguru @ Money, Matter, and More Musings
Let me start with the basic idea of an “emergency fund”. According to my definition of the concept, it’s a pool of money to account for *unexpected* circumstances and *must* adhere to the following three requirements:

1. It should easily available in an emergency (must be liquid and easily accessible through common instruments like cash or checks).
2. There should be a sufficient margin of safety built into it (a part of my answer to the question lies here)
3. It should be held as risk free as possible (you don’t want a devalued pool of investments right at the time of an emergency)

So is there such a thing as too much emergency fund?
I look at emergency funds as a sort of foolproof “hedge” against unforeseen circumstances. For example, it is like a cushion to break your fall and allow your survival if you loose a job (unexpectedly), or if the stock market crashes and you lost a major chunk of your net worth, your house catches fire and your insurance company messes with you and delays payments….things like that. Agreed that these things don’t happen on a regular basis…but they need to happen only once in your lifetime to make you realize the importance of a cushion.

So ideally, your emergency fund should be able to cushion the worst possible scenario (specific to your personal situation) that you can imagine. Add a 20% margin of error to that estimate (roughly) and aim for that emergency amount. The right amount will be something that makes you feel “safe” after considering the worst case scenario. More than that is probably “too much”. Of course, the measure of “too much” will vary greatly depending on your lifestyle.

Where to park the money for maximum returns?
Since I view emergency funds as ‘hedge’ ..returns on these funds are not a major concern. I would first satisfy the above three requirements and then maximize my returns from the available choices. Online savings accounts with ATM and/or check facilities are one of the potential places to park such funds.

If you park your funds in such a place where the funds are not easily accessible, make sure you have an instrument of equivalent value available for use (for example, you could use a credit card at the time of an emergency…and then repay it as soon as you get your funds at a later time).

I understand that I have a more conservative (almost a bit paranoid) approach towards this issue. However, due to the “unforeseen” nature of emergencies, it does merit some consideration.

Silicon Valley Blogger @ The Digerati Life
By conventional wisdom, your emergency fund is parked in a conservative spot. Given that, I would search far and wide for the best returning conservative financial vehicle for this money that should also be fairly liquid so that it is ready to use if needed. Hence, a money market fund that has a good return after tax and fees can be selected. You can do some comparisons among various fund families to find such a MMF.

Yes, there is such a thing as saving too much in the fund. There is also conventional wisdom in this regard that tells you to save 6 months worth of living expenses in your emergency fund. My particular recommendation is to save within 3 to 9 months’ worth depending on your comfort level and ability to save. The more conservative you are, the higher you hike this amount (perhaps even higher than what has been suggested). But consider that you may be sacrificing investment opportunities by keeping too much in your emergency fund. Once this is used, however, you will need to build this back as soon as you are able as you don’t want to get caught without a fund to cover you.

One day, I’ll go into specifics as to how I have built my emergency fund. I have done it as part of an overall investment strategy involving recognizing my particular risk profile so it may be a bit more involved to discuss here.

Emergency Fund Options
Stop by tomorrow to read several different options from the Sun on how you can keep your emergency fund liquid but still earn some interest income on your wad of cash.

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The 4-Hour Workweek: Escape 9-5, Live Anywhere, and Join the New Rich

Someone else’s speeding ticket might make my dreams come true.

Escaping the Cubicle
I was reading about Trent’s speeding ticket late last night when I saw an ad for a new book Timothy Ferriss, the 4 – Hour Work Week. The title of this newly released book makes some promises that sound intriguing.

• Escaping the 9 – 5.
• Living Anywhere I Desire.
• Joining the New Rich.

Count me in!

Punching My Ticket to Easy Street
After checking out the site for the 4 – Hour Work Week and its reviews on Amazon.com I decided to take a chance on the book and see what Timothy had to say about these lofty goals.

I typically don’t fall for such grand promises but it was late and after reading reviews by some people of note, I was intrigued. I’m particularly interested in his experiences on outsourcing life. The book’s on its way, I’ll let you know what I think.

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What’s More Important, Career Success or Family?

I’ve been a fan of the TV show The Apprentice ever since it’s first season. I said before that I think you can learn a lot of business concepts from watching them play out in “real life” on the show. After last night, I realized I learned a life lesson from the show as well.

Success Takes Time
Last night was the finale of season 6 and the lady that was hired to work for the Trump organization will be earning a $250K annual salary to work on a project developing luxurious residences in the Caribbean.

When she was announced as the winner I said to my wife “lucky lady”. Of course, she didn’t win by luck; she came out on top through hard work, intelligence, and business savvy.

One thing I’ve found in the corporate world and in my entrepreneurial pursuits is that success takes time, large amounts of time. It seems you could always do better if you just had more time.

Career Success or Family?
As described in her bio on The Apprentice website, Stefani is a 32 year old lawyer that graduated in the top 10% of her law school class and was selected as a Los Angeles Magazine ‘Young Rising Star’ in 2006 for excellence in law. I’m sure that Stefani’s job as a trial attorney for one of the largest California defense firms kept her very busy and that she’ll be even busier now that she’s working for Trump.

Even though I admire and somewhat envy her new career situation if I was offered the exact same job I don’t know whether I would accept it or not. The time and dedication it would require would mean time away from my family that I wouldn’t really want to sacrifice.

Congratulations
I’m sure Stefani will have an amazing experience in her new job and I congratulate her on the achievement. How about you? Would you take the job or pass it up to give yourself more time to live life outside of work?

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Money Question – Can You Save Too Much in an Emergency Fund?

Any personal finance book or website that’s worth reading will recommend that you save up some amount of money for rainy days; otherwise known as an emergency fund.

Recently a reader wanted to know how much money was too much to save and the best place to keep the money so it wouldn’t be idle:

“Is there such thing as saving too much money in an emergency fund? What’s the best place to keep the money you do save so it still earns you something while just sitting there?”

I asked my blogging buddies for their take on the question and received a variety of answers. I’ll publish their thoughts on emergency funds over the next several days. Today we’ll hear from Henry and the Lazy Man.

Lazy Man @ Lazy Man and Money
I’m going to make an assumption here that the emergency fund is making around 2% after inflation. This seems to be the case with the popular options such as online banks that pay high interest rates.

With that assumption in place, I say that you most definitely can have too much money earning a paltry 2%. With common stock historically returning a 6%+ on investment after inflation, it’s a better place to be in the long term (in my and many other’s opinion).

So where is the best place to keep your emergency fund? For probably the vast majority, the online banks that earns high interest is the way to go. For those who are home owners and comfortable with a tiny bit of risk, I would suggest looking into using a HELOC for your emergency fund. Many people would find the idea of using your home’s equity as an emergency fund crazy. Is it that crazy though? Many people use it for non-emergency situations like home improvement.

Why the HELOC? If you define your “emergency” criteria enough, the vast majority of the average person’s life is going to have very few of them. With any luck, true time of using emergency funds should be less than 5 years. I’m picking that number out of a hat, I didn’t do extensive research. If that’s the case, would you rather pay a tax-deductible 8% (a realistic 6% after tax savings) for years, making 6% for another 55 years of a projected adult life? Or would you rather make 2% for 60 years of projected adult life? I’ll take the former.

Henry @ Binary Dollar
I suppose it’s possible to save too much in an emergency fund but it’s unlikely. If some dude gets in a car crash, would he have:

1) money for a new car in case their old one gets wrecked?
2) money for medical expenses?
3) money for living expenses?

He’d be saving too much in his emergency account if he could cover all of these pretty easily. Unless they have that kind of dough stashed away, most people won’t have to worry about saving too much in their emergency account.

Emergency Fund Options
Henry brings up a good point; many people have a difficult time putting away money for an emergency fund so its unlikely that majority of people would be saving too much. However, if you do have the resources and discipline to build up an emergency fund Lazy Man gives an option for homeowners to get a better return on investment on the money you have saved while still maintaining easy and fast access to cash in the event you need it. What are your thoughts?

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Why It’s Hard to be Good With Money

Every week there are many different websites hosting a collection of articles on a multitude of money related topics. You’d think after several weeks or months people would eventually run out of things to write about.

The reason we always have new topics to explore and discuss is that money is a complex asset with many facets that touch our lives in a variety of ways. It’s difficult to wrap your brain around the depth and breadth of these money issues, that’s why it’s hard to be good with money.

Although keeping up with the many money articles published in blog carnivals every week can be a bit overwhelming, sifting through the wealth of information is a great way to learn how we can be better with our money. Here are a number of money carnivals I’ve participated in and enjoyed over the last several weeks:

• Entrepreneurs
• Personal Finance
• Frugality
• Taxes
• Debt Reduction
• Capitalists

Thanks to the hosts that compiled all of these carnivals. You may not realize it but you’re helping guide us on our journey for financial success!

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Personal Finance Week in Review – Sprinkler System Edition

Spring is here and for me that used to mean hours of dragging around hoses to water our lawn. I’m happy to announce that after a weekend of work our self-installed sprinkler system is back in business!

My father-in-law and my wife’ uncle helped me install a sprinkler system about two years ago. It’s been out of commission since last summer and they made the trip down to help me fix it since it was still “under warranty”, thanks guys! Now I’ll have more time to enjoy the beautiful spring weather and of course write about personal finance. Here are some money articles I found of interest this week:

Both Digerati Life and Lazy Man have interesting comparisons of investing in stock vs investing in real estate.

As the summer vacation season nears KMull warns us about the cash flow implications of renting a car with a debit card.

The new “no hassle” investment option of Life Cycle Funds are becoming more and more popular. The Sun gives us a comparison of Life Cycle Funds offered by Vanguard and Fidelity.

Advanced Personal Finance offers a few pros and cons of using only one financial institution for all of your money dealings.

A wise peice of advice from Henry, make sure you take advantage of free money by investing in your 401k up to the company match.

The Simple Dollar caught my eye when he shared his experience with a side business and asks for the stories of others.

Golbguru extends Robert Kiyosaki’s Rich Dad, Poor Dad concept a little farther with Rich Dad, Poor Dad, Smart Dad, Stupid Dad.

Last but not least, Generation X Finance covers another sign that you could be in financial trouble, Purchasing a Home for the Wrong Reasons.

Have a great weekend!

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