The Lady Whose $50,000 Emergency Fund Wasn’t Enough?

If you're a rainy day planner and a reader of personal-finance blogs, you probably have an emergency fund—some money you've specifically set aside and don't touch, to be available in case something goes wrong. Losing a job. Unexpected medical expense. And so on.

How much should be in this emergency fund? I've seen or heard a pretty wide range of advice on this—from three months worth of living expenses on up to a year. The Wall Street Journal Lifetime Guide to Money says, "Financial experts generally recommend that people have an emergency fund equal to between three and six months' spending money." Personal-finance author and television host Suze Orman seems to recommend at least eight months. (See: Suze Orman's Twelve Steps to Wealth, Step Four (at Oprah Magazine).) In an economy such as we have now, one might argue it's desirable to have a bigger emergency fund. 3, 6, 8, 12—how important are these "months of living expenses" targets?

This past weekend, Suze Orman told a caller into her television show that she couldn't afford a $3,300 "luxury coffee machine" because her $50,000 in savings was not enough of an emergency fund.

The caller's profile looked like this:

• Age 44
  
• $11,500/month income (combined with husband)
  
• $330,000 mortgage, 15-year fixed at 5.75%
  
• $10,200 monthly expenses (including mortgage)
  
• $50,000 in savings
  
• $2,000,000 in retirement accounts
  

So not only did the caller have $50,000 in cash, she (and her husband) had $2,000,000 in retirement. Suze Orman's point was that they couldn't (or in most any case shouldn't) touch the retirement funds, and they were only able to save a small amount each month based on the difference between their income and expenses—and what would happen if one of them lost their jobs?

Now many things crossed my mind at this point. What type of person would spend $3,300 on a coffee machine in the first place? How exactly does one spend $10,200 a month—not just here and again but as the amount of your regular monthly living expenses? How the heck did they get the $2,000,000 in their retirement accounts? And am I really going to sit around and watch personal-finance shows now that the Olympics are over?

Using an online mortgage calculator, I figured the caller's mortgage payment at about $2,740/month. Based on the information reported, it didn't appear that the caller had any other debt (such as car loans, personal loans, or credit card debt)—as those items are usually noted for callers into the show. So what was the caller having to do with the other $7,460/month in living expenses—totaling $89,520/year! This one's a head scratcher for me and made me wonder if the caller miscalculated her monthly living expenses. The couple accumulated $2,000,000 in retirement accounts by the time one of them was age 44. Perhaps the husband is older, but the $2,000,000 still made me think they had to have been pretty good savers for many years—even though they apparently have some expensive tastes (such as a $3,300 coffee machine). Is it possible they're including their contributions to retirement accounts as part of their monthly living expenses?

When I do rough calculations of our monthly expenses, I actually do start by including our retirement contributions and other automated savings and investment plans. My thinking is that, even under an emergency, I'd hope to keep those savings and investments going. Of course, if the emergency came and were severe, we would be able to scale those back and stretch funds farther.

I actually have to confess we no longer track a separate emergency fund. When I first started paying attention to my personal finances, I started setting aside some money each month for an emergency fund. First, I aimed toward a more modest three months of living expenses; and later, I built up toward six months. I married my wonderful wife; we got our personal finances together fairly well; and at some point, our cash position became strong enough that keeping a separate line item or account for an emergency fund and calling it an emergency fund no longer seemed important. I would look at our cash reserves compared against our monthly expenses here and again—but I stopped keeping a line item labeled, "Emergency Fund," and having it in a separate savings account, and so forth. I probably need to take a new and closer look at that, unfortunately, as we have depleted some of our cash position with our landscaping project.

My two cents on emergency funds can be summarized quickly (and may not be worth much more than two cents):

• I do think it's important to have an emergency fund. It's very hard to recover from a disaster without one, and disasters are much more common that we (or at least I) would like to think. And the earlier you are in your personal finances, the more important an emergency fund is—because the less likely you are to have other assets that you can tap.
  
• The "recommended" sizes of emergency funds are decent targets—but they're just rules of thumb, meaning they're shortcuts if you don't want to dig deeper. Of course, your first emergency fund always starts at some amount way less than what people recommend. The best path for many may be setting a more modest and attainable goal for your emergency fund, reaching it, and then considering a new goal. What you really need in your emergency fund is individualized to you. The size and need for your emergency fund will probably also depend on things like how stable your job is, how quickly you are likely to be able to find a new job if needed, how much and how quickly you could reduce your monthly living expenses if needed, how good your insurance is that insulates you from some of the types of emergencies that are out there, whether you have any alternative sources of income apart from your job, and so on.
  
• Bigger is better—to a point. At some point, I think you could have too much money sitting in cash, earning a low interest rate (possibly or probably less than inflation). At some point, you may want money in other assets that you could liquidate quickly, if needed in a particularly bad pinch.
  
• I think the habit of having and building an emergency fund is almost as important as the emergency fund itself—because it also develops general saving habits that you can continue in other parts of your personal finances.
  
• When you get to the point that you can save outside of your emergency fund, some of the conventional wisdom is to then save in retirement accounts (and at least to the point of getting any matching funds provided by your employer as a benefit). I think that that advice is fine—but at some point, it may make sense to keep some of your savings and investments outside of retirement accounts. In my post looking at what made up the net worth of personal-finance bloggers, I found that: "Every one of the millionaires had over $250,000 in stocks (outside retirement accounts) and over $250,000 in retirement accounts." In my view, the caller we've been discussing would have been better served to follow suit—and have diverted some of their retirement savings along the way to non-retirement investments.
  

What about you—do you have an emergency fund, how much is it (or how many months' living expenses are in it), and how do you calculate your living expenses (if that's part of how you are figuring your emergency-fund goal)?

Related Posts:

The Lady Who Wouldn't Pay Off Her Credit Cards Even Though She Had The Money

The Lady Who Wouldn't Pay Her Mortgage

Lessons from the Millionaires — What Makes Up PFBloggers' Net Worth? (Part 3)