Wednesday, March 05, 2008

How Our Emergency Fund Helped Us Retire Early

Building and maintaining savings for emergency needs has always been part of our wealth building plans. Having a financial cushion has provided a sense of financial security, because there was a safety net upon which we could depend. Luckily, we never had an emergency need while we were earning a wage income. As a result, our savings for emergency needs helped us achieve early retirement in our forties.

Why you need $500 in the bank by Liz Pullian Weston of shares how to get started with $500 in an emergency funds. The article concludes with some examples of what constitutes an emergency and what doesn't. "Essentially, it's an event that puts your livelihood or your family's safety at risk. The television dying, for example, is not an emergency. The furnace dying is."

Here were some of the guidelines we used for our emergency fund:

  1. Limit using unexpected use to true emergencies. We only considered one or two events true emergencies. They were job loss or catastrophic medical expenses. Fortunately, neither of these ever happened to us while we were working.

  2. Keep the majority of funds in cash or cash equivalents. For us, it would have been disastrous to have emergency funds invested in the stock market and then need to use them when the market is down. An emergency is bad enough. Needing to sell when the market is down makes the emergency even worse.

  3. Emergency funds shouldn't replace insurance coverage or saving for routine large expenses. To me, emergency funds should be in addition to and not instead of major medical, auto, home and liability insurance. Also, I would consider large purchases (e.g. car, furniture, electronics), car repair, and major home repair (e.g. roof, furnace, or air conditioning) to be planned expenses and therefore, not a reason to use emergency funds.

    The Chief Family Officer writes how she created and infrequent bills savings account because they were using emergency funds to pay for "routine" large bills. Before getting married, I used to co-mingle emergency and big expense (e.g. car, real estate tax) funds and reconcile the amounts periodically. In the last couple years, we created a separate big expense fund, for items such as home repair, car purchase and insurance premiums.
We have always made regular contributions to our savings, both for emergency needs and retirement. Since we were fortunate not to have any true emergencies, our emergency fund was never used. Eventually, the unused emergency savings became part of the funds we used to enable retirement in our forties.

For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2008 Achievement Catalyst, LLC


emilyg said...

I am a recent college grad working at my first full-time job, and I just started an emergency fund a few months ago. Before my first paycheck, I had a few weeks with no income, and boy was I miserable. After reading lots of articles and blogs suggesting having an emergency fund of at least 3-6 months of expenses, I've made it my goal to save save save. If for some reason I lose my job or have a major emergency, I will feel so much better knowing I won't have to rely on credit cards. I'm also working to build up my travel fund, but I don't have a big expense fund. I figured that would fall into the emergency fund since I'm young with no house and a new car, but you made a good point about how it can get complicated mixing the two. Thanks for that point -- I think I may need to open another savings account for that in the near future.

Chief Family Officer said...

Thank you for mentioning my article. That Infrequent Bills Account has been really amazing at keeping our savings growing!

retire-at-40 said...

That sounds like a fantastic outcome. I too have recently started both my Emergency Fund and what I call my Freedom Fund (for those irregular bills).

I'm hoping that my Freedom Fund is oversupplied and keeps going up slightly. I also hope my Emergency Fund is something I'll never need and keeps going up a lot :-)