By conventional wisdom, a strong emergency fund is considered a staple of good financial practice. The standard advice is to have 3-6 month’s worth of living expenses in a savings account that can easily be accessed when emergencies arise, such as periods of unemployment or unexpected medical bills.
But personal finance is personal, and the standard advice isn’t right for everyone. I’ve seen a number of different personal takes on why someone either does or doesn’t have a sizable emergency fund and today I wanted to share two in particular that stood out to me as being particularly thoughtful.
Building an emergency fund vs. paying off debt
Jacob from iHeartBudgets wrote a great piece this week explaining why he chooses to keep several thousand dollars in a savings account when he still has over $13,000 in student loans at 6% interest. You can read it yourself here: Is My Emergency Fund Too Big?
Essentially, by choosing to keep his money in a savings account that by my guess will earn him at best about 1% per year, he’s giving up the opportunity to get a 6% guaranteed return from paying down his loans. From a mathematical standpoint, using a big chunk of those reserves to pay down the loans is a no-brainer. Many of his readers thought so as well.
But here’s the thing. Good financial practice is not all about maximizing returns. There’s a place for that, but there’s also a place for sacrificing returns in the name of safety. When you start to look at Jacob’s entire situation, his logic for keeping the money in savings makes sense. Not only does he have a wife and a young child who depend on him, but they have another child on the way (congrats by the way!). This is a classic example of a situation where financial stability takes precedence over maximizing the return on every dollar. If he used his savings to pay down his loans, it’s certainly likely that he would end up with more money at the end of the day, but it exposes him and his family to greater financial risk if they were to hit a rough patch.
While there are certainly cases where paying down debts makes more sense than keeping a large emergency fund, I think that Jacob’s approach is perfect for his situation and is an example that many parents can follow.
The young, single person’s emergency fund
Mario at Debt Blag has a slightly different situation and therefore a slightly different approach to an emergency fund (though not quite as different as it might seem at first). You can read his take in full here: Why I don’t keep a lot of cash around in an emergency fund.
Mario’s situation is different from Jacob’s primarily in that he doesn’t yet have a family to support. For that reason alone, in the event of an emergency it would likely be much easier for him to dramatically slash his expenses than it would be for Jacob. He gives a great breakdown of exactly how he would do this, and the difference between his expenses now and what he could get to at the bare-bones level is pretty striking.
The other great piece of his article is how much thought he’s put into the alternatives to keeping the standard 3-6 month emergency fund. He’s paying down his student loans at an interest rate of 7.9%, an excellent return. He’s maxing out his Roth IRA, which in an absolute worst case scenario allows you to withdraw your contributions tax and penalty-free. He’s taking advantage of an employer match for his 401(k). He’s considered how he could not only slash expenses, but pick up some extra income in the event of an emergency. All of this thought has allowed Mario to give himself enough security to feel safe, but also take advantage of the opportunities that his situation is affording him.
I love these two articles because they are both incredibly thoughtful approaches from two very different viewpoints. Each of them has figured out what works best for their personal situation, which is really what personal finance is all about.
Here at Mom and Dad Money, I try to give you the tools that will allow you to manage your money effectively for your family. There are a lot of rules of thumb that serve as a great starting point, but in the end every situation is different. Financial success requires that you have a fundamental understanding of the principles in play and the strategies available to you. But then you have to evaluate your specific situation and pick an approach that work best for you.
Other articles I think you’ll like
The Pops: Along with Mr. 1500, Mrs. Pop breaks down the logistics of biking to work. I have to admit that while this is something that has always intrigued me, I’ve never taken the plunge. This article was really helpful though in terms of thinking about how it would work.
Financial Samurai: Sam has a cool breakdown of the impact of talent vs. effort in determining our success. The conclusion I like best is that if success is largely driven by effort, then the power to improve our lives is in our hands.
Cents and Sensibility: With all of the talk out there about finding a practical college major, could it be that a liberal arts degree is really the way of the future?
Thrift Genuity: LinkedIn can be a powerful way to build a professional network and bolster your career. How are you using it?
Budget and the Beach: How much are your habits costing you? What habits could you change that would improve your financial situation?