The traditional personal finance advice is that everyone needs an emergency fund, often with absurdly unrealistic amounts of cash (6 month’s salary or more) stashed in a savings account losing money to inflation. This is a horrible waste of capital in my opinion and while my approach isn’t for everyone, I also want to highlight that not everyone needs to adhere to the cookie-cutter advice doled out by “professionals” when it doesn’t reflect reality or the best use of funds. Let’s start at the beginning of my post-college career and walk through how much better off I am by having NOT stashed half a year’s worth of income in a savings account.
- First Job – I started fresh out of college with no credit card debt and only some student loan debt in the form of an interest-free loan I paid back to my parents over my first 5 years out of school. It was totally manageable and my salary was decent, as I entered into a mediocre job market but had an in-demand degree (see unemployment by major). While I was able to bank some of my excess income, I was also saving for a ring, and I also wanted to buy a house right away. If I had waited to save half a year’s income, I would have had to forgo both – probably for at least 2-3 years. I mean, how quickly can you actually save half a year’s salary when you have to pay current living expenses, contribute to a 401(K), pay back loans, etc. So, I didn’t build an emergency fund.
- Within 1 Year, I Bought a Home and an Engagement Ring – As soon as the 1 year lease was up on my apartment, I plopped down the bare minimum on a home (3%). While many people gasp at this move, putting down more than you have to is foolish in my opinion. The only entity you’re helping by putting down 20%, 30% or whatever, is the bank. Nowadays, yes, there is PMI, which tilts the equation in favor of putting down at least 20% to avoid that cost, but given the choice between waiting years to buy a home with 20% down or just buying one today with next to nothing down (if you are so inclined), I’d buy the home and try to get the equity up to 20% quickly and refi out of the PMI. Regardless, I bought the home, proposed, and took a nice trip to the Caribbean to boot – because I didn’t have an emergency fund.
- Fast-Forward a Few Years – We had saved enough that I probably did have equivalent to a few months’ salary and had our first kid. Rather than leaving all that money in the bank over the years, I’d been investing in a Roth IRA, maxing out my 401(k), putting money into the kids’ 529 plans and enjoying life – Hawaii, Europe, and more. We also decided to move to a larger home when our second child was due, so we sold the first home and booked a six-figure gain to use as down-payment on the next one. In that case, we cleared the 20% threshold to avoid paying PMI. I’m not sure if following that transaction if we had what would be considered a full 6 months cash remaining or not, but then we had our third kid and put in a swimming pool rather than blindly hang on to probably close to six figures in cash.
- More Recently – Again, over the years, rather than leaving money in cash, like a true emergency fund must be, I’d accrued various CDs and more retirement funds, but also established a ~50,000 account in a routine taxable trading account. I’d seen it grow from probably 35K to 50K over several years of bull markets. Well, a seemingly great real estate opportunity came around and it’s something I’d really wanted to branch into for a long time. Not just for the higher returns, but also to diversify my asset mix. The investment required was roughly $50,000. I had a few choices. I could liquidate all my taxable investments, triggering lots of capital gains, or I could do a 401(k) loan, or I could pass. I didn’t want to pass, and didn’t feel paying thousands of dollars in taxes now to avoid the 401(k) loan was the right move, so I borrowed $50,000 with 401(k) loan.
What If I NEEDED an Emergency Fund?
For one, early on in my twenties, my expenses were low and I had been accruing funds in a 401(k) which could be tapped in a catastrophic emergency. Next, my wife was graduating the next year and ended up with a job as well where we were living off my salary alone and her salary was gravy. Finally, the job market was tight enough and my colleagues were jumping ship left and right to competitors so I knew if something happened at my employer, it wouldn’t be long until I was employed again. After all, there’s severance, unemployment and other companies. In a 90’s economy, you’d have to work really hard to stay unemployed for a year with a Chemical Engineering degree.
Fast forward to today. If I were to be laid off tomorrow, first off, I’ve probably accrued at least 8-12 months’ severance by now (not really sure the exact number), and the federal government is just now starting to wean people off the 99 weeks unemployment insurance. While we couldn’t live off $2500 a month, in the meantime, I could freelance/continue to collect money from blogging, my wife could substitute for a couple grand a month and before you know it, we’d be at least, say, $6500-$7500 a month with a much lower tax liability, so after tax, we wouldn’t be in horrible shape – and this would only be for the span of a few extra months it would take me to get a job. Let’s say it took me a full year and I only had 8 months’ severance (which, by the way, I’d be saving all the extra blog money along the way during those 8 months, since severance is full salary).
So, if I go back and recap all the things I COULDN’T HAVE DONE had I always carried a true “emergency fund” of 6 months cash in the bank, here’s how my life would be different:
- Never would have bought my first house in time to…
- Buy our second, larger home we live in now
- Would have put off marriage longer
- Probably would have put kids off longer and only had 2 instead of 3
- Never would have traveled as much and had incredible memories to live with
- Never would have bought a swimming pool
- Never would have invested in college rental properties OR the CAD Outsourcing business I forgot to highlight (still churning right along)
- and more.
In some regards, you might say, “well, hindsight is 20/20 and you just happened to be lucky”, but to that I’d say that I have always been able to gauge the economy, my field and career prospects pretty well. Now, I’d say this is a riskier approach to be sure, but if you know that your skills are in demand and you see colleagues hopping left and right to competitors where you don’t even have to relocate? And you’re young and in good health? And you want to get more out of life than living the life of a pauper so you can play it safe? Well, then maybe this approach is for you.