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Emergency Reserve Fund Planning

51hh
  |     |   1,853 posts since 2010

From MerrillEdge:

Sorry, cannot be published.  Some quotes below:

Calculate how much you may need:  "An emergency fund should be large enough to cover at least six months of living expenses. That way, if you lose your job or face unexpected expenses, particularly over an extended period, you can leave long-term investments untouched, working towards their intended goal. The amount is different for everyone. Base it on an honest account of monthly and other predictable expenses, such as upcoming home repairs or replacing a car."

Keep short-term cash risk-free and accessible:  "Put at least the first three months’ worth of savings in an interest-bearing, federally insured checking account or money market savings account, so that it’s essentially cash with no withdrawal penalty. The goal is to have limited risk associated with this portion of your money and always to have the funds available. For money that you won’t need right away, look at building a “ladder” of short-term certificates of deposit. You can do this by buying individual CDs with staggered maturity dates."

Yeah, yeah, keeping six-months living expenses is the golden rule.

But that is just a guideline; nothing wrong with six months income or two years worth of expenses.  This is just a rule of thumb. 

Just like the (120 - age) for equity coverage, or (110 - age), now it is (100 -age) or (90 -age)...

There is no right or wrong answers; so do not forget who started this new rule:

One should save at least 9.353 months of expenses as an emergency fund according to Rhett's detailed financial analysis and statistics!:D  Obvious reason #1: it takes much longer to find jobs in a bad economical climate such as this one.

Cheers,

51

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pearlbrown
  |     |   2,298 posts since 2010
In the summer of 2007,  the early 30’s grandson of a dear friend was awarded a certain sum in settlement of a suit.  The amount was about 1.5x the grandson’s household income, and the family of 4 (SAH wife + 2 10 – 12 year olds) had little in savings so this was a wonderful opportunity to establish an emergency fund and start thinking about how to pay for college. 

Reluctant to listen to parents or grandparents, and eager to be able to casually mention their portfolio at the next opportunity, they approached “Aunt Pearl” for advice on how to invest the funds.    Over a couple of pizzas we discussed their goals and why an emergency fund and not an investment portfolio needed to be their first priority.  A couple of weeks later we finally had compiled together a comprehensive list of  what monthly expenses would need to be covered if he lost his job, discussed where to park the money, what constituted an emergency, etc.  and they said they would take it from there.   

Apparently it was easier to hear the advice from someone outside the family than from Mom and Dad, but to their disappointment it was just as conservative.  And at 30, one is, after all, invincible and all-knowing. 

They apparently had second thoughts and immediate acquisition of various tech gadgets (which they replaced with the next big thing six months later) and other “keeping up with the Joneses” items was redefined as an emergency.  The lure of bragging rights to a portfolio which was invested based on tips from a friend-of-a-friend and traffic on Internet message boards also proved irresistible. 

Fast forward to a year later:   he has lost his job, family savings only amounted to 6 weeks of expenses, and hot portfolio was (no surprise) a fraction of the original amount.    Time to find a new job:  18 months.   Credit card debt:  Astronomical. 

Moral of the story:  six months or 9.353 months – the first order of business is to get people to actually commit to establishing and respecting an emergency fund.    The old adage about leading a horse to water has stood the test of time for a reason.
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klink
  |     |   202 posts since 2012
Very good advice and story. I've gone to 2 years worth of emergency funds covering all monthly expenses. Each month every expense gets a set budgeted amount. All this maintained in a MM/Acct. with easy access. I also purchase a short term CD ea. month as it pays slightly more than the MM/Acct. I don't worry about the loss of a job but I do fret over the other wage earner in the household passing away which is always a posibility.
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pearlbrown
  |     |   2,298 posts since 2010
I think the conventional 6 month figure is a bare minimum, especially in this economy.  On the plus side, though, it is a good starting point, and less overwhelming for most people (if they will only commit to it), so it doesn't seem like such an insurmountable goal.  And even better, as they develop the habit of paying themselves first, they are also developing the discipline that will serve them in meeting other financial goals and they are at least on the path to building some measure of financial security for themselves and their family. 

To me, the other plus is that the process of identifying what expenses need to be covered and in what amounts can be a wake-up call if one is smart enough to think about what the numbers are revealing.  There are no "right" or "wrong" expenditures, of course:  if it's a personal priority / reflects a personal value then it's a "right" expense, although naturally there at times when every personal priority cannot be supported at the same time.  But it's food for thought and for valuable discussion. 

Finally, another factor which IMO also needs to be addressed when discussing an emergency reserve fund (and  often is not) is the person's age.  It may not be politically correct to mention, but it appears that over-50's are much more likely to be affected by layoffs, or to be effectively forced into early retirement.  When employers are looking for ways to cut costs, higher wage earners, who are often the ones with the most tenure or the highest technical skills, are often targeted, even if that means that a great deal of knowledge and experience is being dismissed.  Unfortunately it can be much harder to find other employment at that point, much less at the former wage, so someone in that age bracket might be smart to double or even triple the emergency fund if possible. 

I like 51hh's 9.353 months rule of thumb LOL, and 12 months makes me even happier.  Klink, my hat is off to you for the 2 years of coverage.   Like you, I budget and track expenses monthly and annually. however, instead of short-term CDs I prefer to keep my emergency funds in reward checking accounts, even if it means there is some work involved (tracking cycle close dates, number of transactions, etc). because of the higher interest earned.   Either way, the important thing is that we are keeping the money readily available should a sudden need present itself. 
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klink
  |     |   202 posts since 2012
Thanks "Aunt Pearl". You can bet I looked into Rewards Checking before my decision on CD's. My main problem was I couldn't meet the minimum monthly debit (transaction) requirements. I would be open to other suggestions if you have any.
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Wil
  |     |   242 posts since 2010
Pearl and Rhett: Great advice, should be in boldface! But I think the people who need to hear your advice, and story, most are probably not listening. Suze Orman, on her weekly TV show, has been saying this for years (she recommended eight months living expenses minimum for an emergency fund). Though I have ceased to regularly watch her program, her emphasis on the importance of an emergency fund was admirable. In a worst case scenario, however, you can withdraw your contributions from a ROTH IRA without penalty, so that could be a potential back-up to your emergency fund, though one that I would tap last.
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paoli2
  |     |   2,603 posts since 2011
I may not be your average saver since I do things differently for my emergency funds.  I always have a CD maturing each year or so and it gets put in our savings account to pay for additional or unexpected bills I think we will have for a certain period.  I just don't like thousands of dollars sitting in a bank savings account earning practically no interest until I need the money.  I just had a CD mature and it's sitting in our savings account because I know I will need the funds soon.  Let's face it.  All CDs just can't rollover when they mature.
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