Everybody talks about how to build an emergency fund, but I have designed the best emergency fund ever. That’s right, you need not read any more on this topic after you finish this post because my idea is PERFECT. Your welcome.
I recently wrote about how I didn’t feel that an emergency fund was important when I was getting out of debt. That’s because I had enough positive cash flow each month to handle most emergencies, up to $2,000. Instead of setting aside cash, I planned to pay for unexpected expenses out of my paycheck.
When you have an emergency fund it might help you for one month when you are in debt, but if you spend it you will just have to cut your debt payments the next month to build it up anyway, so what’s the point?
But now that I’m out of debt and facing the prospect of a career change for next year, I think it’s important to save up six months of expenses in case of unemployment or underemployment.
My plan is to save $10K By New Year’s Day. I came up with this number by following my Job Loss Emergency Plan (read it here if you haven’t had a chance). It’s a nice round number that I feel will allow us to survive six months of unemployment, with some sensible cutbacks.
The BEST Emergency Fund Ever
A lot of dispensers of personal finance advice tell you that you need an emergency fund, but don’t tell you how to set it up.
Because I’m building one now, I’m going to share with you how to set one up.
The emergency fund I’m designing has four layers, each a bit harder to access. All four layers consist of cold, hard cash. That’s because you shouldn’t have your emergency fund in anything other than cash. Not in a mutual fund or brokerage account. Just cash.
In addition to keeping it in cash, you should also pretend it doesn’t exist when it comes to calculating your asset allocation. For example, I will probably save for retirement using the permanent portfolio (25% of assets in each category of stocks, bonds, gold/silver bullion and cash). I will not be counting this $10,000 cash as part of my allocation plan, though it will figure into my net worth.
Layer 1 - Cash at Home
It’s important to keep cash at home, but not too much (in case of fire, theft, spending impulses, etc).
A good amount to keep at home is $1,000.
This amount should be enough to cover the immediate needs of most families (whether it’s bailing your drunken spouse out of jail at 3 in the morning or paying that scary looking locksmith who only takes cash).
A thousand dollars is a suitable amount, but not enough to elicit much worry of loss due to fire or theft (invest in a good, heavy fire safe that can be bolted to the floor).
If you are afraid to keep cash at home, get over it.
If there is some type of natural disaster that shuts power off to your bank and ATMs, you won’t be able to use your credit or debit card at the store to get emergency supplies like food and fuel for your car or generator. If they are open and running on generators, it is almost a certainty that they will be accepting cash only.
Layer 2 - Cash in Your Linked Savings Account
What is a linked savings account? It’s just a savings account with the bank that holds your checking account. You should be enrolled in online banking so that you can link the accounts together and easily transfer money between them.
For my setup, I will be keeping $2,000 in this account.
Having a linked savings account is useful in case you need to write a big check or make an unexpected payment from your checking account. Having them linked means that you don’t have to wait for transactions to clear. Once you transfer already-cleared funds between them, the balance change is immediate.
This is useful if you make an error when balancing your checkbook and realize that you have less money in your checking account than outstanding checking payments. A quick transfer from your savings to checking can fix this error until your next payday, when the money is replaced.
Having it in your savings account also means that you can access it at an ATM no matter where you are, though daily withdrawal limits may inhibit how much you can access. Check with your bank in advance to find out your limit.
Layer 3 - Cash in an Online Savings Account
These days online savings accounts are pretty common, and often offer the best interest rates.
I will be putting $3,000 in my online savings account at SmartyPig.
An online savings account is used because this is the hardest of all to get money from. It requires me to log in and transfer it back to my checking account, a process that takes a few days.
Make sure you choose one through a reputable bank, and one that has a good interest rate.
Layer 4 - Cash in a Safe Deposit Box in Another Town
A safe deposit box is a locked and secure box (usually at a bank or financial institution), that is accessible during normal bank hours.
It is useful for storing cash, jewelry, important papers, bullion, collectibles, and more.
By having it in another town, it is harder for you to access, which makes it less likely that you will get into your emergency fund cash on a whim. This also means that if there is some type of natural disaster in your hometown, one where the power is out indefinitely, there is a good chance that the other town you’ve chosen (if far enough away) still has power, allowing you to access your money.
My parents live about an hour and a half from me, near where I grew up. I plan to open a safe deposit box there, put in $4,000 in cash, and hopefully (if the bank allows), also grant access to my parents in case I am incapacitated.
Diversified, Accessible, Tiered, Separate, All Cash and Forgettable
Using my $10,000, you can see I’ve broken it up this way: $1,000 (Layer 1) + $2,000 (Layer 2) + $3,000 (Layer 3) + $4,000 (Layer 4) = $10,000.
If you want a $20,000 emergency fund or don’t like the way I’ve allocated the money, feel free to change the numbers up.
Just keep in mind that the BEST emergency fund is one that is set up in tiers, each harder to access than the others. It is also diversified, meaning your cash is spread out in multiple locations in case of calamity. It is also cash-only, so don’t put it in your Roth IRA.
Most importantly, it is separate from your other assets and asset allocations plan. The best emergency fund is one that you forget is there.
I don’t know about the safe deposit box in another town, but everythign else makes alot of sense. Especially the cash at home part — I never really thought about it, but that’s a great plan! You never know when that ATM won’t work or credit card machines bust.
Seeks like a great set up for you. Having most of my money in an online bank could be troublesome and I need to get some emergency cash as well… more things to add to the to do list!
You know I used to think of an emergency fund as when you un-expectantly needed a new roof or air conditioner. But you really put the “emergency” back in emergency fund. You could survive a natural disaster with this type of setup! I love putting your money in a box out of town. I would have never considered this, but it makes sense.
I often joke with some of my clients (particularly ones that lack discipline) that they should have their emergency fund in a savings account in another town…one that is at least 30 miles away. This will ensure that you only go there if it’s an absolute emergency!
For us, I’m not into having multiple emergency fund accounts. Although…I like the idea of having some of it at home even though we don’t personally implement that strategy. For me, I might go with the linked savings account and look to put some in our safe at home. $1000 seems about right for the completely liquid money.
I agree with Jason above although a regular savings is not for me. I would rather go with a CD ladder but that is personal preference. I also like the idea of cash at home in a safe.
I’m not sure that I agree with the idea of the money needing to be hard to access. After all, if there is a real emergency, I would think that the money needs to be readily accessible at a moments notice. That’s why investments such as stocks and mutual funds make for such poor choices as emergency fund vehicles.
Now, if you were to say that you have a credit card with a high limit that you have put away for such occasions and you would then use the cash you have stashed all over the place to pay it off when the bill comes, then I would be in total agreement, as you would have a tough time getting at the cash but still have the credit available to cover all emergencies. Of course, that assumes an ability to not touch the card for frivolous matters in the meantime.
Interesting! I’m happy with my set up - $7k instantly accessible in online savings, another $3k in another online savings account with another bank (could take a couple days to transfer) and of course my credit card.
Admittedly, I do ladder some of that $3k in term deposits when rates are good.
Hmm, I have never really thought about the “doomsday” scenario before, ever! I should definitely look into putting at least a hundred or two into the safe at home. My spouse and I frequently don’t have cash, or only have $10 or $20. There’s a pot of change at home, but who knows how much is in it, as we usually take the high value stuff for coffee! The only tricky part will be not succumbing to the temptation to take cash from it instead of going to the ATM, because we’re lazy.
Thanks for sharing
I completely disagree with Eric. Emergency funds should completely be hard to access…so that you don’t jump on it when the first “opportunity” hits that you can’t live without.
One question, John…how many times have you had to bail your drunken spouse out of jail? The locksmith I’ve seen before…the other….not so much.
I’ve never seen it broken up this way, but it appears to be an excellent method. I’ve always just kept all my emergency savings in one cash savings account at the bank… now you have me thinking about better alternatives…
and I thought I was the only one around that actually still used real cash!
I agree with most of these scenarios/solutions, but I’m not so sure about the safety deposit box out of town. That seems a little doomsday-ish. Of course, if a person is more likely to dip into their ER fund at the drop of a hat, then maybe that’s a good “outta sight, outta mind, and hard to get to” place to keep it.
Interesting set up. I like the cash basis you have, but I think I’d break mine up a little so there’s not so much cash out there. I’d rather collect at least a little interest. Maybe a savings account out of town so that I could access the cash if absolutely needed but could still collect a little interest. Or maybe bullion in a safe deposit box; it should increase in value as it sits.
Hey, I think that sounds great….and as long as it works that is all that matters!