Justifying 3-6 Months of Expenses in Savings
First, thanks to Megan for asking the question. The Dave Ramsey debate is still raging on so if you haven’t weighed in, please do so! We’d love to read your opinions. But Megan asked how we can justify leaving 3-6 months worth of expenses in a savings account only paying 3% when there are clearly other investments that can offer a better return.
The answer: that money is intended to cover expenses in the event you lose your job, become disabled and unable to make payments for a period of time, or if something happens to one of the breadwinners in your family. Yes, there are certain insurances that cover most of these things; however, most have stipulations on how long before they kick in, how much and how long they will make payments, and even as to what will be paid. There is no such insurance for being laid off. Can your family really afford to take the risk of not being protected in the event one of these scenarios takes place? Can your credit report afford it?
Some people have suggested the use of credit to cover these types of emergencies; however, I think that’s asking for trouble when you start relying on your credit cards to cover your monthly expenses without the intention of paying them off at the end of the month. An occasional emergency here and there isn’t a big deal and a good reason to have a credit card in the first place. But we’re talking about having at least six months of expenses saved here. If you lost your job and were out of work, how would you pay the credit card back? You could end up defaulting on the card and disparage your credit report in the process. This is also why I think it is important to have the savings account and contribute as much as you can until you reach the six month’s of expenses, even if you have debt. Again, if your income is suddenly gone, how would you pay for anything? Credit is an option for a while, but eventually that runs out and the bills have to be paid. What then?
So for me the justification is simple: I need this money just in case something was to happen to me or in case I lose my job. I would rather only be paid 3% and pay no penalty fees if an emergency comes along as opposed to earning a better rate of return in investments but then have to pay penalties and taxes if I need the money. Not to mention the fact that investments can lose value and even though I started with six months, I could potentially have nothing if I ever need it. Investments are meant for the long haul, pulling out early could hamper your earnings. However, there is no need to have more than six months expenses saved at any one time. I’d say more than that and you’re losing out on better opportunities.
Still, that liquid savings account is fairly hard for some folks to swallow and I completely understand. Another option to consider would be certificates of deposit (CDs). Now, CDs aren’t 100% liquid; however, they are 100% safe and your money will be there when you need it. Most institutions will charge you a fee to withdrawal early, but most don’t touch your principal, only your interest. So, if you ever need that money, it’s there and it’s safe; but it’s also earning a little better than just a savings account. That option is completely up to you. I personally like the savings account because I just don’t like to spend money when I don’t have to. But that’s just me.
What do you think? Is it justified, or just a waste of time?
Related posts:
Our small-town bank offers an “electronic” savings account, and it’s nearly matched ING in interest over the past year. The benefit to a local e-savings is that I can transfer money instantly between accounts, instead of waiting the 2-3 days that ING and other online accounts take to transfer. It CANNOT be accessed at the bank or with a debit card – we still have to log on to the website to move our money.
As a side note, the bigger banks (PNC, M&T, ect) are starting to offer their own electronic savings accounts. Check if yours is offering this!
Our interest rates are odd around here – CDs are earning less than the money market and electronic savings accounts.
You can also ladder CDs, staggering the term of CD so that you have multiple CDs and one will mature every 3-6 months. Personally, I just use ING direct for the simplicity, even though I could probably get an extra 1% interest by going with CDs.
If the interest rates go up, I might reconsider putting half my emergency fund into a CD. I would probably always keep at least one month’s expenses in savings for easy access, even if I put the rest of my emergency fund into a CD.
No one really argues with Dave’s main point of living on less than you make. He doesn’t claim to have the ONLY way when it comes to some of the details. I am kind of biased though. I love Dave’s approach.
We pretty much did Dave’s plan with a few modifications from the wife. The end result though was being Debt Free. It is really impossible to quantify or put into words what an experience it is to owe not one dime to anyone in the world.
FJH
daveramseyguru.com
Think of the 3-6 months in savings as insurance. Its insurance that if all goes wrong you won’t have to go in debt. It can also give you a sense of freedom to make more liberating decisions and it gives you peace of mind. Personally peace of mind so I can sleep easily at night is so worth the potential investment income I might be loosing.
Couldn’t you combine the ladder CD approach with a savings account so that you have 1 – 2 months immediately liquid and the remaining 4 – 5 coming into liquidity every other month? For me I’m not sure it would be worth the hassle but if your concerned about maximizing interest while maintaining the security it seems like you could do something along those lines.
Having 6 months in savings is a great goal but with all things it is important to take into consideration all your financial goals. Time is your greatest asset and delaying just 6 years to begin investing can have a devastating impact on the funs you have available when you finally retire.
For example $200 dollars a month with an average of a 12% return for 35 years will return ~ 1.3 million if you wait 6 years that is further reduced to a little over 600K.
if your a more conservative investor and your investments 200 a month over 35 years returned on average 8% you would have ~458k and delaying 6 years would leave a little over 270k
Of course losing your job would affect this plan as well but there is always the example of the person that put 2000 a year for 6 years and stopped and the other person that waited 6 years and continued to put more money in for the rest of their working life and still ended up with less money than the person that stared sooner.
It all depends on where you are and what you want your life to look like and how much time you have to work with before you can determine if it is justified or not.
You raise an interesting point, SK. The idea isn’t to just focus on one asset at a time, though. We need to have a savings account in place, this is true, but we also need to be investing in our retirement. I’m not suggesting that one should take precedent over the other, because in my mind they are equally important. I think the object should be a to find a healthy balance of what you can contribute to each one. When I was building my savings account I took a 50/30/30 ratio. That is, I took 50% of my disposable income and applied it to debt, 30% to savings, and 30% to investments. This specific ratio worked well for me.
“That is, I took 50% of my disposable income and applied it to debt, 30% to savings, and 30% to investments”
Just to nitpick, I assume you mean 50/25/25? The other version adds to 110%
Yikes! Thanks for catching that! That is what I get for multi-tasking and talking about finances at the same time. But yes, I meant 50/25/25.
By the way, you should always nitpick when it comes to finances! ;)
[...] “rule of thumb”, it would seem this is a hot topic among financial concerns. At Master Your Card, Kristy on Monday discussed the importance of the emergency fund, and while I agree with her that [...]
3-6 months of expenses is crazy. You can invest all the money, if you lose your job you’ll be liquidating it anyway.
Personally if you are debt free and truly saving and building wealth, then investing the money is not a huge deal. You’ll have 1+ years of income in a taxable account. And you won’t liquidate it all at once.
So having an EF isn’t a huge deal. My DH explains it all as a large pot of money. Right now we’re not quite at that point of having enough in taxable accounts, so I can’t say that we are fully invested.
But in the next 5 years I am pretty certain we’ll have 1-2 years invested in a taxable account. So it won’t really matter.
I’m kind of with SK and Kristy –
I think the goal is a good one, but that you have to take other financial goals into consideration. I only have a month of income in my emergency funds right now, but I have other huge financial goals that I am also trying to take on – so, I need to balance everything.
[...] Your Card presents Justifying 3-6 Months of Expenses in Savings posted at Master Your [...]
[...] [...]