My Emergency Fund Looks A Lot Like A Roth IRA and a Credit Card

The real troubles in your life are apt to be things that never crossed your worried mind, the kind that blindsides you at 4 pm on some idle Tuesday.

– Mary Schmidt, Advice, Like Youth, Probably Just Wasted on the Young

 

True story. Three years ago, my wife and I were driving down I-85 through South Carolina. Just north of Greenville, I was cruising in the fast lane when the car in front of me veered abruptly to the right, revealing something rather unexpected. Nestled firmly about fifty feet in front of me was, as I’m sure you all would guess, a loveseat.

Yes, as in, “Wow Dan, that’s a nice loveseat”.
Yes, as in, “Hey baby, let’s go fool around on Dan’s loveseat.”
Yes, as in, “Yeah…we should probably clean off Dan’s loveseat before he wakes up.”

Back on topic and back on I-85, I instinctively hit the brakes and swerved, narrowly avoiding the loveseat and any motorists on my right. Dodged it! Phew!

My relief was short-lived.

You’ve probably been in enough living rooms (like Dan’s) to know that where there is a loveseat, a sofa is often close by. As it was, the sofa was one lane over (now my current lane) and about ten feet in front of my Sonata—a Sonata which was still moving at about 60 miles per hour. And then…

Boom.

Thankfully, all of us were okay. But, the car was gone. And just like that, in the blink of a couch, we were standing on the side of the highway…no car…one cat…400 miles from home…150 miles from our destination…at 7 am…on a Sunday.

Roll up your sleeves boys and girls, a moment like this is why life is interesting.

Emergencies: Just A Part of Life

You might call us connoisseurs of emergencies. We’ve had ER visits, hit-and-runs by a drunk driver in a stolen car, chipped teeth, flooded basements, broken-down ACs, shot-out furnaces, flights for funerals, several layoffs, and the list goes on. I would imagine your list goes on, too.

The story of the couch ended well for our family. A police officer was not far behind us and saw the wreckage on the road. Another motorist reported the moving van that had apparently secured its load using nothing but hopes and dreams. We called our insurance company, and when all was said and done about six months later, even our deductible was covered. It’s a nice story, but between the couch impact and the moment the check arrived in the mail, everything was on us: a few rental cars, a couple train tickets for another car, the new car down payment, an extra day off of work. It’s a major inconvenience (as most emergencies are), and is precisely why my emergency fund was so crucial—except that I didn’t have one. I’ve never had one. I never will have one. And least not an emergency fund in the traditional sense.

The Emergency Fund: Not Just For Personal Finance Articles

Okay, let’s take a step back.



What is an emergency fund? Answer: A pool of cash that is highly liquid (easily tapped) in the event that you have an emergency that requires you come up with some serious cash on the spot.

What is an emergency? Answer: Anything that is a must-do that requires an amount of money that you don’t have coming in on the regular. Common examples are a leaky roof, a faulty furnace, broken pipes, a death in the family, getting fired, a medical emergency, your car breaks down, Uncle Leroy’s bail, etc.

An emergency fund is a little like education reform—everyone’s in favor of the idea, but nobody can agree on the specifics. Dave Ramsey, the cat’s pajamas of personal finance, in his first baby step, says to get a $1,000 emergency fund and then build that up to 3-6 months of expenses. Suze Orman, everyone’s favorite skin-pulled-tight Saturday night financial advisor, goes a step further. Not wanting to stop at 3-6 months, she recommends that a full eight months of expenses should sit idly in a passbook savings account. The figures and multipliers vary depending on which back-of-envelope you’re consulting, but I’ve seen everything from a flat $500 to a full year’s income (nevermind the irrelevance of either of these figures).

The Opportunity Cost of An Emergency Fund

It is readily acknowledged by the financial media that an emergency fund won’t give you much return. That is not its purpose. An emergency fund is meant to provide you security, safety, and a sound sleep. The thinking goes, when you inevitably encounter an emergency that requires you do pony up some dough, it is far better to have it on hand than to:

A.) go into debt,
B.) withdraw from retirement (perhaps with a penalty), or
C.) not be able to cover the expense, thus jeopardizing your health or safety.

So, the basic tenet is: put a pile of cash equal to 3-12 months of expenses, depending on your lifestyle, in a nice FDIC-insured account and only touch in on a rainy day. Sleep confidently.

Who can argue with that? Answer: Retire29 can.

Okay, let’s take Suze Orman’s example. Right now, we spend about $5.5k per month. Therefore, my emergency fund should be about $44,000. Say what?!

You mean to tell me, I’m supposed to have $44k wasting away in a savings account, getting MAYBE 1% interest? All the while, inflation is trucking along at an average of about 2% and historical market returns would be giving me 11% dividend-reinvested total returns?

No thanks, I’ll take my emergency fund elsewhere. Where, elsewhere? How about the good old stock and bond markets? Rather than let inflation erode my emergency fund, I have my emergency fund grow nicely in discounted corporate (JPS) and municipal (CMU) bond ETFs. These highly diversified vehicles charge relatively low fees, and have been giving me strong ~10-11% total returns for almost a decade. And, I’ll also dabble in the stock markets, and when the time comes, I’ll access my emergency fund from my taxable brokerage or, if the emergency got truly terrible (like a long-term job loss), from my Roth IRA principle. In a Roth, the emergency fund can grow tax free and the principle can be withdrawn at any time, for any reason, without tax or penalty.

Now, rather than have my emergency fund grow by a paltry $30-40/month in interest, it’s now growing at a dividend-fueled $300-$400/mo. With each month that goes by without emergency, the size of emergency that the fund can handle grows exponentially. What’s not to love?

Another reason to keep your emergency fund invested is that it creates a small psychological barrier to spending. As Steve Miller, a blogger points out below in the comments, an emergency fund in deposit accounts can easily be tapped for “wants” rather than true emergencies. If you are forced into selling securities to get the cash, that additional act forces you to make a decision that the item is truly an emergency.

Negative Nellie Files a Retort

But, Eric, ETFs and stocks, especially in IRAs, are not always liquid.

 

Au contraire, mon frere. They’re just about as liquid as a savings account. If the markets are open, then I can have that cash in hand in about five minutes. How? Sell shares at market, transfer the cash to checking (my checking account is through E-Trade, same as my brokerage), and I run over to the local ATM and pull it out.

Wait, you said “if the markets are open.” What if they aren’t?

 

You mean like, on Holidays or at night? Well, I would counter that if the federal reserve is closed, then your money market or CD assets (two popular emergency fund vehicles) are just as inaccessible as my stocks and bonds. However, I guess you have a point. On a holiday weekend, I could be empty-handed for up to three days (more on that later).

There is no stability in stocks and bonds. What if you are forced a sell at a terrible price?

 

Ah, yes, the popular, “you’ll be forced to sell at the bottom” argument. My guess is the same people who make this claim also make claims that nobody can time the market. I agree with the latter claim.

Sure, if I have an emergency and I need to sell at 9:31 a.m. on August 24th, 2015, I’m going to have to sell for a pretty terrible price. However, If I have an emergency at 4 p.m. on May 20th, 2015, I will have a sold for a great price. The point is, you never know when you’ll have an emergency, and you certainly won’t know how markets are doing at that given moment. You might be forced to sell with the S&P at 2,000. That would look pretty bad if the S&P goes to 3,000 a year later, but it would look pretty savvy if the S&P fell to 1,000.

What I would say, though, is that an emergency fund should be in safe-ish assets, meaning, not individual stocks. Stick with low-fee ETFs like VYM, or some of those bond funds I said earlier (JPS or CMU).

Okay, I got it. Roth IRA contributions or taxable brokerage balances serve a reasonable way to access funds in the event of an emergency. But, what about if I need the money like, right away? Sometimes accessing a brokerage can take a few days (like your long Holiday weekend example).

 

Well, I use a credit card.

(cue the moans from the crowd)

No, seriously. And why not? Credit cards are a great solution for emergencies so long as you have assets that are reasonably accessible (within 30 days) to pay the bill. I did this just this summer when our car A/C went out. Not a life-or-death sort of emergency, but definitely something that needed to be addressed pretty quickly. I had the cash to cover it, but why not use a card instead? It was essentially a 50-day interest free loan. Not to mention, using a card (thru the benefits of card hacking) earned me a few hundred in free travel.

This has worked for generations. Have you ever heard an older person say, “we only use the credit card in emergencies.” Yep, I’m bringin’ it back.

Okay, fine, but what about if I need CASH, like, right now? The cold, hard stuff. When a card is not an option.

 

I think I might need to see some examples of what sort of emergencies you’re talking about. I’m not sure I’ve ever come across a true emergency that required cash in hand and on the spot. Is there a ransom note involved?

But, alright, I’ll play along. So, I actually ‘get’ that it’s nice to have some cash in the bank. You want some flexibility to withdraw cash to do with as you please, or to maybe fetch a nice deal on something if you can offer cash. In business terms, this is called quick assets, and it’s nice to have some around to know you’re not on the knife’s edge will creditors. For this reason, I always keep about a month’s worth of expenses (~$5k) in checking. This is enough to know that I’ll be able to pay my bills even if my paycheck gets held up, and if I want to go to Aldi (debit card only) I won’t overdraft.

At the same time, $5k isn’t so much that I feel like I’m really losing out the opportunity cost of dividends and capital gains.

In Conclusion

Two-thirds of Americans already have less than $1,000 in emergency assets. By saying “don’t bother with an emergency fund”, I’m probably not doing any favors to a society that already is living hand-to-mouth. Thankfully, this is not what I’m saying.

What I am saying is that having funds available in an emergency is imperative. However, “available” is a concept that seems dated. We seem to live under this belief that “available” needs to be some low/no-interest deposit account that is but one step removed from a mason jar under the sink. It doesn’t have to be. Far better, in my opinion, is to have a huge emergency fund, but in assets that are growing exponentially.

If you disagree, I’d love to hear why.

If you enjoyed this, I would really appreciate you sharing this with a friend (share buttons below!), or maybe even subscribing (also below).

Thanks so much for reading Retire29!

Love, Eric

14 Comments

  1. Great article Eric, First let me just say that if you have a months worth of expenses in your checking account not only are you doing better than most you have an “emergency fund” right there. Say something does happen and you need to spend an extra $2000 right away, well that’s fine because you already have $5000 in the checking for the bills this month, and you can just build that back up rather than having to take money out of a savings or retirement account. Second I love the Roth Idea and am planning on using that myself to invest and save with because of that fact that I can take the principal back at any time.

    • Tyler,
      So glad you’ll heed the advice. It has worked through countless emergencies for well over a decade, including lots of layoffs. So, I’m confident it can hold up. Seeing the “fund” grow every month through dividends is also reassuring.

      Eric

  2. This actually makes a ton of sense and is what I’ve been trying to get across to my wife for awhile now. We spend $3-$4k a month which would quickly be scrunched down in a true emergency situation to $2k to $3k so having $10k in the bank is plenty and having our current balance is overkill. I also question the odds of a two-income household both losing their jobs at the exact same time. Obviously it’s a bit different if there is only one income but what Suzie and Dave forget is that *most* people find a new job fairly quickly. I think we’ll adopt your strategy of using Roth + Credit Cards and trim the cash balance.

    You could probably watch Suzie’s show every week and write a new post based on the less than stellar advice given out. My pet peeve from them is “pay down your debt so you can do something nice for yourself”
    Mr. Benny @ Stuff That Pig recently posted…Tuesday Morning Bluster: Fore! Bad Decisions!My Profile

    • Lol, “pay down your debt to do something nice for yourself.” Yah, that’s about as bad as it gets.

      We’ve lived through countless emergencies with this strategy, and it’s never been a problem. And I echo your sentiments on finding a new job quickly. I’ve lost a lot of jobs, and I’ve never been unemployed for longer than six weeks. Could I be unemployed for longer? Sure, but that’s no reason to have a huge pile of money do nothing. In the remote chance something like that happens, I’ll have a growing brokerage or Roth IRA balance to back me up.

      Eric

  3. I once hit a bed mattress on the highway that I didn’t see soon enough in the dark, though luckily it didn’t do too much damage. I also don’t have a traditional emergency fund in low yielding safe assets either due to the opportunity cost of money sitting around. My emergency fund consists of an after-tax investment account + HSA. I view money in a Roth account as more valuable since it can grow tax free. If you have money in after-tax accounts to cover the emergency why would you choose to use the Roth account instead?

    • Hey Mark,
      I would use the taxable accounts first, I should’ve made that more clear (editing now). An HSA is even better, given that the deposits, growth, and withdrawals are all tax-free. That is pretty awesome.

      Eric

        • Hi Mark,
          Roth IRA withdrawals are documented by the filer on Form 8606, which needs to be filed with your 1040 at tax time.

          Since all funds are fungible, any withdrawal from an IRA is first contributions, from earliest year to latest year, and second, any gains on contributions. In essence, you couldn’t withdraw “gains” even if you wanted to (unless you already withdrew all of your contributions).

          Eric

  4. Great topic. Emergency funds are great and I am believe of them. However, I’ve seen people dip into those funds for “wants” not “needs”. In other words, they see a nice sofa (not laying on the side of the road) and say, well we have money in the emergency fund — buy it!

    I like to keep mine for true emergencies (illness, unexpected house or car expenses, etc.)
    Steve Miller recently posted…Why it’s important to have Twitter Followers (and how to get them)My Profile

    • Steve,
      Great point, and another example of why emergency funds shouldn’t be in deposit accounts. By keeping them invested, it creates one more hurdle against spending on wants!

      Eric

  5. The returns on cash are just so horrible right now that keeping a large cash reserve just doesn’t make sense. Even for the really frugal that only spend $1,500 a month that would be $18k for 1 years of expenses just sitting there. You might as well keep it under the mattress collecting dust.

    Typically I like to keep about 1-2 months expenses in actual cash. I like the idea of accessing the Roth IRA principle if it’s a really bad emergency that needs more cash than you can handle through cash flow from your job/dividends/current cash balance.
    JC @ Passive-Income-Pursuit recently posted…3M Is A Wonderful Company But Not A Buy HereMy Profile

  6. Good article, you’ve convinced me to go at least a bit more this direction. I think the main counter argument is a catastrophic scenario, where the stock market crashes, you lose your job, and there’s no certainty of when you’ll go back to work (think 2009). If your house went underwater and your Roth IRA balance got cut in half, it’d be a pretty stressful time while you were raiding your IRA (or racking up credit card debt) to pay all of your expenses not knowing when things would turn around. Albeit, this may be a 1-2 time per generation occurrence. Of course if you lose your job for 6 months, get by on unemployment and a few grand from your Roth, then everything goes back to normal this plan seems fine. I’d like to see a follow up addressing more of a “worst case scenario” where the economy sheds jobs for 2-3 years.
    dh recently posted…The Epic Mortgage Payoff Dilemma (Part 1)My Profile

    • Or, you could imagine a scenario where you lose your job, your family deserts you, you become disabled in a car accident, the stock market drops by 80%, your identity gets stolen, your insurance company goes out business the same day your house burns down, and……

      You could go on with “worst case” scenarios, and quite easily go past the point where even a year-long emergency fund is laughably inadequate. The vast majority of emergencies can be dealt with using just a few tools like credit cards and safe investments in a taxable brokerage or Roth IRA.

      Eric

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