### The Alternative Emergency Fund Strategy
Lately, there have been a lot of discussions and strong opinions about having an emergency fund, and I wanted to share my thoughts and experiences. I have a love-hate relationship with emergency funds. They’re essential for critical situations, but saving enough can be a real challenge. The recommendations I see range from 3 to 12 months of your gross monthly income. For a typical American household earning $60,000 a year, that means saving between $15,000 and $60,000. No wonder so many people struggle with this!
Another issue is that once you start saving and get close to that $15,000 mark, your mind starts wandering. You think about using that money to pay down debt, contribute to your Roth IRA, or invest in something else. Before you know it, you’re back to square one.
Let’s forget about the emergency fund for a minute and focus on your budget. Imagine if, over the next few years, you worked towards an ideal budget. This would be great because:
1. By budgeting properly and diverting funds to various savings goals, you’ll have more “streams” to pull from in an emergency. These streams are important things you put money towards voluntarily, like your 401k, Roth IRA, or fixed-rate savings account.
2. You’ll learn to live with fewer expenses. Covering 40% of your income is a lot easier than covering 70%. So, you’ll need less money when you’re in a tough spot.
You still need to save for an emergency fund. If your finances ever hit rock bottom, you’ll need a cushion to survive. But, with a proper budget and living on less, your emergency fund goal can be lower. Instead of aiming for $15,000 to $60,000, you can aim for a “Reduced Emergency Fund” of $6,000 to $24,000.
Here’s how this strategy can help in different scenarios:
**Scenario 1 – Times Are A Little Tight:** Borrow from your Reduced Emergency Fund. If that’s not enough, redirect money from lesser priority streams like “Extra Debt Payments” or “Extra Savings” to cover the expense. Aim to get back on track as soon as possible.
**Scenario 2 – Things Are Really Rough:** Suppose your car breaks down, or you have a major home repair. Use the tactics from Scenario 1. If that’s still not enough, you may have to raid higher priority streams like “College Savings,” “Roth IRA,” and “401K.” Try reducing them rather than stopping completely, and get back on track quickly.
**Scenario 3 – The Lost Job:** This is the worst-case scenario because losing your job means losing your primary income. This is why having a Minimum Emergency Fund and keeping expenses low is crucial. You may not be able to save for retirement, but you won’t starve, and you can cover your main expenses. Letting your savings goals sit idle will hurt, but use that pain to find a new job and get back on track.
In extreme cases, you could:
1. Withdraw the principal from your Roth IRA after five years.
2. Borrow against your 401k, with plans to repay it later.
These should be last-resort options, as early withdrawals can sabotage your retirement savings’ growth.
Lastly, losing your job usually means losing 100% of your income. That’s why it’s smart to diversify your income with passive sources in addition to your job. If you had other passive incomes, your need for an emergency fund would diminish further. Plus, who doesn’t want more money?
—
1. How to Budget – Introduction
2. What Should Be in Your Safety Net?
3. What Would You Do With An Extra $1,000?
