In the world of personal finance, having an emergency fund always seems to be a popular topic. The reason for that is that it is important to have cash on hand. You never know when you will need to access cash due to an emergency. When it comes to the topic of having an emergency fund, there are many different schools of thought about why you need cash and where to keep the money.
The general rule of thumb is to have between three to six months of living expenses in a checking or savings account. The theory behind that time frame is based on the loss of a job. If you lose your job, the experts say that you should be able to find a new one in less than six months. Having enough cash to cover six months of living expenses is a nice cushion. It allows you to be able to pay your bills without having to charge up a high credit card balance or take on other debt until you find a new position.
I have been laid-off twice during economic downturns. The first time I lost my job was when I was in my early 20’s and the second time was when I was in my mid 30’s. During both of those layoffs, I had a nice cushion of at least six months of expenses in cash. When it happened in my 20’s, it was less stressful because I had limited responsibilities. In my 30’s, I had a house and a wife, so I had a tremendous amount of responsibilities.
Looking back, however, I never touched the emergency money in either of those two cases. I was eligible to collect an unemployment check, so I collected that benefit. In both cases, I was only out of work for a few months. I actually still had enough money to fund my IRA both times with the money I received from unemployment.
Having an emergency fund has helped me out the most due to unforeseen expenses. Cars seem to need to be repaired at the most inopportune times. Owning a home always comes with unforeseen expenses because household items wear out. Also, health insurance does not always cover all of your medical expenses.
Our most recent car expense was an exhaust system on my wife’s car. She said that her muffler sounded like there was a hole in it. We took it to a shop that specializes in mufflers and they said it needed a new exhaust system. The mechanic showed me the exhaust and it was rusted out. The total cost was $850. We plan on keeping the car for a few more years, so we did not have another option other than having a new exhaust put on.
We live in a rural area. Last winter our water stopped flowing. The pump broke on our well. Fortunately, there was not deep snow in our yard at that time, so the well was not buried. The cost to replace the pump was $1000. It would have been more if they had to bring in equipment to dig out the snow and ice. Not having running water is an emergency.
Last summer, my wife was complaining about pain in her mouth. She went to the dentist. She needed a Root Canal. Our Dentist referred her to an Endodontist. The dental insurance did not cover it. We had to pay $750 out of pocket. Another example of an emergency.
A common topic of discussion linked to the topic of having an emergency fund is where do you put the money? Keeping it in your house is not safe because it can be stolen. It is also not suggested to keep the money is an index fund that invests in stocks. An FDIC Insured savings account is a much better option, but the national average on interest rates are around 0.32%. Certificate of Deposits (CDs) can be a good option, but you have to lock the money in for a few years to get an interest rate that is more than 2%.
I currently keep our emergency fund in the Vanguard Limited-Term Tax-Exempt Fund (VMLTX). I just count it towards part of our asset allocation in bonds. Over the past 10 years, it has returned 2.4%. It is not FDIC insured, but it is a short-term bond fund with an average of 3 years to maturity. It is rated by Vanguard as having the least risk potential in their family of bond funds. The most important factor is that I am comfortable with it as a holding tank for money that I might need for unforeseen expenses.
In my experience, it is always a prudent idea to have access to some cash in case you need it. You never know what is around the corner. It can be a loss of employment, a major repair bill, or even an emergency that is tied to a natural disaster. Some say cash is trash and others say cash is king. In my opinion, it is better to have some cash earning a low return than having to go into debt because you don’t have money to cover an expense.
Do you have an emergency fund?
If you do, how many months of living expenses do you keep in your emergency fund?
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