(Read parts one and two in the emergency funds series)
In the first two articles, I covered:
- How important it is to be cash flow positive
- How to cover very small shortfalls with credit
- How to cover truly large expenses with different forms of insurance.
The most important large unplanned expenses that could potentially be covered by an emergency fund are the expenses related to a job loss. For the other large expenses you might be dreaming about, see my earlier articles and understand the need for insurance (since no reasonable EF can cover $100k+ expenses).
So... what should you do in case you lose your job and need to avoid piling on the high interest debt? Simple: raid the brokerage and retirement accounts!
Raiding Retirement for Emergency Funds is Suboptimal!
Withdrawals from a Roth IRA up to the amount of your contributions are tax- and penalty-free. In the case of an extended job loss, any funds should be considered available for withdrawal.
At first, this may seem like a startling idea... shouldn't retirement be prioritized above all else?
When you are earning an income, yes. The need for short-term liquidity takes top priority over retirement. The solution may not appear to be the most ideal, but the true cause is the job loss, not the fact your brokerage account is approximating the suggested emergency funds of other bloggers.
Remember the first step to this solution is becoming cash flow positive.
Is there a better solution?
Taking $15,000 from an emergency fund to cover a job loss.
Taking $15,000 from a Roth IRA/brokerage account to cover a job loss.
Either of these solutions impacts your net worth by $15,000, the only disadvantage to the second being that the Roth IRA's tax advantages are foregone and can't be made up. (This goes away if it's a regular brokerage account.)
In short, this rare circumstance with negligible downsides and tangible upsides is not enough to persuade me to hold a significant portion of my net worth in cash... especially with interest rates ~0.50%, before tax.
Why Try to Change Minds About Emergency Funds?
I mean, all personal finance is personal! (Just kidding.)
Personal Finance very rarely is personal. It is usually dry, universal and oftentimes not sexy.
I have just become fed up with the end of any PF discussion on the internet being to "develop an EF" as the panacea for all money ailments.
Are you considering grad school? EF.
Are you considering traveling? Well, you need an EF first.
Moving? Child? Purchasing a house? EF. EF. Oh, and EF with 2 years of home maintenance included.
There is an argument to be said for risk aversion but this solution is very often trite, incorrect and counterproductive. If somebody doesn't have high interest debt, this is all just intellectual hand-wringing. But when a person prioritizes emergency funds over CC debt payoff, they are actively hurting their battle toward financial independence. To not miss the forest for the trees, the first step is to become cash flow positive. Raise your income, lower your expenses, save the difference. Then these arguments become less important!