Saturday, June 16, 2007

Wealth First . . . then Emergency Fund

So the accepted conventional wisdom is that you should have a 3-6 month emergency fund readily available, either in cash equivalents like a high-interest internet savings account, money market account, or in a rolling CD ladder. In fact, Trent, the world's most prolific personal finance blogger, reccomends you have a 12 month emergency fund.

I have a 1 1/2 month emergency fund. which I only have because 1) my beat up 15 year old car is on its last legs and 2) I may have some big medical bills coming up to pay for.

If you want to retire early, you need to focus on building wealth first, and having an emergency fund second.

Investing in a 5% money market account would cause you to double your money in 14.21 years, but investing that money in the market at the historic 10.5% return will double your money in less than 7 years or half as much time. Every little bit of money you can put into equities and higher returning investments makes a big difference (especially if you factored in the fact that emergency funds are taxed at the short term rate, while stocks are taxed at the long-term capital gains rate).

But what about having enough money to avoid using bad credit sources?

No question if it is a choice between incurring high interest credit card debt and having an emergency fund, you should go with the emergency fund, but I don't think the choice is that simple.

With less cash on hand, you are less tempted to spend extravagently, because you are literally working without a net. Additionally, there are other sources you could draw upon in the event of an actual emergency: you could sell your stocks (no reason I couldnt do this while using my 1 month emergency fund), or you could take out a HELOC (tax deductible) or a 0% credit card transfer, or borrow money from a relative.

The point is to get as much money, earning as much as possible, as soon as possible, so you can break through the ceiling.

3 comments:

q at $1 Million to My Name said...

Bravo, I completely agree. I have 0 months in my emergency fund. Emergencies don't happen all that often. If the do, I have $40,000 available in my Home Equity Line of Credit. In 7 years, I have never had to tap it for an emergency.

All of my available cash is invested, and I feel like that's going to give me the best chance to retire on my terms.

Alex said...

Nice.
My hope is to eventually get where you are at. I still have some debt repayment to clean house on my finances.

QUALITY STOCKS UNDER FOUR DOLLARS said...

Its always a good idea to be ready for an emergency.