Abby Freedman Perry of I Pick Up Pennies had an interesting piece on her blog the other day about emergency funds. It started an interesting conversation in the comments about the nature of an emergency fund and how to save the recommended six months worth of expenses. I thought I would share with you how J and I handle our emergency fund, since it seems to be different from how most financial gurus recommend you do it.
As I mentioned several months ago, J and I use ING Direct for our mid/longish term savings. We in fact have 13 separate savings accounts (all under one umbrella, of course). Those accounts are:
France (We're specifically saving for this on top of our vacation fund, although we'll probably also have to use money from vacation when we do go).
License and Taxes (for renewing our cars' plates, etc).
LO's 529 (I put aside 3% of what I make until I reach enough money to make it worth putting in the 529 itself).
Mortgage Savings (When we bought our house, we shopped around to find the best rate. We saved ourselves a quarter of a percent, but we paid and paid for it with terrible customer service and incredible stress caused by our lender. That quarter of a percent only saved us $30 per month, so we decided to actually bank that money each month and do something exciting with the $5400 we'll have at the end of our 15 year mortgage. We figured living well was the best revenge for dealing with incompetent/crazy-making underwriters).
Project Car (J has a 1976 BMW 2002 which has not run in the 9+ years I have known him. It's a work in progress).
Synagogue (For our yearly membership dues).
Taxes (Since I'm self-employed, I need to make sure I put aside taxes from each of my paychecks. Putting the money here until I need to pay it earns me a little interest).
If we strictly followed Dave Ramsey's advice on emergency funds, that would be the largest of our savings accounts by far. But we actually only put $50 per month aside in our emergency fund, and because of relatively regular use, it's almost never over $1000. It's certainly not full of six months worth of living expenses.
There are two reasons for that.
1. About a third of J's paycheck (which is what we live on, while mine is used to pay off my student debt and save for retirement) goes to our savings categories. If you add in the cash we set aside for our envelope budgeting, it's just over half of his pay going to our savings and spending categories. A big emergency (like a job loss or a major natural disaster or a zombie apocalypse) would mean we'd stop doing all the moving of money into our savings accounts, and we could reduce our cash spending by a lot (since only a few of our cash spending categories are zombie apocalypse necessary). So we'd need a great deal less than 6x J's monthly salary to have six months worth of expenses saved up. A grand still wouldn't cut it, which is why:
2. We consider all of the savings categories together as our Big Emergency/Zombie Apocalypse Fund. If the financial worst were to happen, we could say "The heck with the new sofa/car/mortgage lender revenge! We need water and plywood to board up the windows."
This system works for us because we know that we are saving for specific major purchases that we want, but we also have the security of knowing that a big chunk of money is available if we ever need it.
The only downfall to this system is figuring out if something constitutes an emergency. Since our emergency fund is somewhat feeble, it can feel strange to take a big chunk out of the account for something that might or might not be an emergency. J and I get around this by being willing to borrow from other funds if necessary. For example, our car replacement fund is fairly robust, since we put the equivalent of a car payment in it each month. So emergencies involving our cars that exhaust our car repair envelope will often be paid for by the replacement fund.
J and I are both too impatient to wait for an emergency fund that is completely full before starting to save for fun stuff. We have used this system for about five years, and even though our emergency fund has never reached a really high balance, we've always been able to find the money we need in order to pay for unexpected expenses while still saving for our goals.
Is there anyone else who "cheats" like this in creating an Emergency Fund? How do you save for a rainy day?