Russell Nagami's Blog

The general advice for an emergency fund is that it should be enough to live for six months.  For me that’s 9000$ with my current budget. I recently started separating my money differently. I now put cash intended for investing in 10,000$ batches in a separate savings account and was wondering if I should create one for an emergency fund. After giving it some thought, I realized I didn’t want 9000$ sitting around earning almost nothing and that the general emergency fund advice is wrong so there really is no need for me to.

After thinking a bit I have determined that for me, an emergency fund really only needs to cover one thing: losing my job. To come to this conclusion I asked myself two questions:

1. Are there any other emergencies that would require an emergency fund?
2. If I lose my job, what in my budget do I really need and what do I not need?

Let’s start with number one. What about a non job loss emergency, for example car breaks down. The answer is simple for someone following the principles of Early Retirement Extreme, the money I save on every paycheck from my job to invest can go towards that emergency instead of toward investing.  Since I save more than 50% of every paycheck, this is quite a lot of money and can cover any emergency I can think of that wouldn’t be covered by insurance.

Now for number two, what do I really need in my budget if I lost my job? To stay alive, I would really only need food money. I already don’t have a cellphone bill, a car payment, a mortgage, etc. If I lost my job, I’d have no reason to stay where I am since I’m here for my job.  I could rent out my room and then move back in with my parents, or baby sit for relatives and mooch a guest room, or couch surf with friends, etc.

So, all I really need is food money!  Someone very frugal could live off of 100$/month, but I’m more in the 250$ to 300$ range. That means my emergency fund only needs to be 1800$. That’s less than I keep in my checking account to make sure I have enough for auto rent/credit card payments, so there’s really no need for me to maintain a separate emergency fund.

Put simply, if you save a large amount of your paychecks, your emergency fund only needs to be as large at 6 months of your emergency budget, which is your budget minus everything you can cancel quickly.  If you can’t cancel your cell phone bill, car payment, mortgage payment, etc, you’re going need to have a lot more. If you can live in a tent and hunt for food, you don’t need anything.

18000$invested. 24000$ to be safe.  I just looked up the price of an iPhone plan on ATT and the cheapest one was 60$ a month. Ignoring upgrades to new phones, taxes, and fees, you would need 18,000$ invested returning 4% after inflation to pay for that invested (using the rule of 300, 24,000 is more conservative using the rule of 400).  After capital gains tax, taxes/fees on the plan, you’re probably looking at closer to 25,000$ invested to pay for that minimal cell phone plan (unlimited talk/text, lowest data at 300 MB).  I don’t know about you, but to save that much money for me would take at least a year of working.  Speaking for myself, a cool cell phone is not worth one year of 2o’s.

Just as a note, I write dollar signs after numbers, because we say in English “five dollars”, not “dollar five”, so why not write 5$ instead of $5? Logically we should write dates 20140508, it self organizes on computers and makes the most sense for comparing dates (comparing May 5th, 1776 to May 5th, 2014 shows the same first two numbers despite a large difference in date which is is worlds apart from comparing May 6th 2014 to May 5th, 2014, showing a one day difference in the sameyear). However, in the US we say “May 8th, 2014” which is why I believe we tend to write it in this manner. As an interesting side bar, many other countries write “8-5-2014” to indicate the 8th of May, 2014.  When signing documents I now tend to write the month by name to avoid confusion.

That’s how much money you make for usage when comparing against a purchase. Assuming you’re not in a very low tax bracket, earning your income with a job, and contribute to a 401k.

Dividing by two is a simple trick to put the cost of something versus how much you make in perspective.  If you make 50k and think 25k is a good amount to pay for a car, at first glance it seems reasonable.  But divide by two and to account for federal taxes, state taxes, social security, medicare, 401k contribution, medical, and dental, you’re really only taking home about 25k per year.  So that 25k car is going to cost you all the money you earn in a year, assuming you don’t spend any money on  food, water, a place to live, gas/insurance for said car, some kind of entertainment, or anything else.

Assuming you live very cheaply on 12.5k per year (and I doubt you do, that’s 1041 a month, less than rent for many people), that means you’d have to work for 2 years just to feed yourself and buy the car, with no savings except your minimal 401k contribution. So really it should be divide by four, because after all the taxes and living expenses, that’s what you’re left with.

Oh and so far we haven’t accounted for the tax you pay on the car, or the interest accruing on the loan taken out on it.  Add another 6 months of work to account for those factors.  Now ask yourself, is it worth two and a half years of my life to buy this car?

So, when you want to compare your income to the cost of something remember, divide your income by two. Or better yet, four.