Posted by Tim Stobbs on July 15, 2008
Ok after some thought I’ve finally figured out what drives me a bit nuts about emergency funds. Most people that save one always end up having too much money in them. Why? The don’t break down their expenses to the essential payments.
Let’s face it. When things go REALLY wrong you are likely to want to take a few measures to ensure you are going to be fine. So some expenses are just going to go. Cable TV will be gone and so will high speed internet. Long distance plan will be gone too. You will likely going to cut down your spending to your essential items.
So if you are going to use a rule of thumb like 6 months of expenses, do it on your essential expenses not your regular expenses. For example, my regular savings/spending amount is around $3200/month. My essential spending is around $2300/month. Which would mean I would have about $5400 less in an emergency fund.
The advantage of this is two fold: a) it is easier to save that much money in the first place b) you don’t have too much money tied up in low yield investments (like a high interest savings account).
I personally don’t have a dedicated emergency fund, but rather a larger cushion of savings in various accounts and a handy line of credit. Why? Because for those odd times I need an emergency fund I can borrow up to $10,000 for a low cost of $40/month. I can float that loan for a lot longer than burning up my savings directly. I’m comfortable with this and it works for me. Yet if you like the security of a emergency fund I suggest you think about doing an essential one.