First, my car wouldn’t start. Turns out I needed a new fuel pump. Then, my Macbook had a fatal crash from the top of the refrigerator. (The Jimmy V speech was on at halftime of an Illinois basketball game and I wanted to listen while cooking.) To top things off, a pipe burst inside of my house.
On the good but also expensive side, I became a CERTIFIED FINANCIAL PLANNER® certificant (about $450 worth of fees). A good friend of mine was married (hotel room+gift). My wife and I booked a trip to spend a few days down in Florida. It’s Christmas, and well, Christmas isn’t cheap. Oh and one last thing, my wife’s last day at work is December 30. She’s is quitting her job, to start her own business in 2011.
The purpose of this post isn’t to make you feel sorry for me. This stuff happens to everyone. The real purpose is to discuss the hidden benefits of an emergency fund that I didn’t understand until I went through a few paychecks in just two weeks.
# 1 – Peace of Mind
I have around 14 months of living expenses, sitting in cash or other short-term investments earning next to nothing. (I wouldn’t normally have this much, but my wife and I are both making career changes) This is about 8 months more than the general rule of having 6 months of savings for an emergency fund. Yet, if I had anything less, I wouldn’t be able to sleep at night.
The opportunity cost of earning a greater return by investing some of my emergency fund into higher returning investments, is a tax I pay for peace of mind. This is one tax, which I’m glad to pay over and over again.
# 2 – Career Risks
You never know when that once in a lifetime job or opportunity is going to come by. Most of the time, it’s gone before you know it.
By limiting your emergency fund to a bare minimum, you also minimize the risks you can take. The few hundred dollars a year you might earn by having a small emergency fund, pales into comparison the amount you can earn by taking just one career risk.
For example, John has a $24,000 saved up in an emergency fund. Since John spends $2,000 a month, this emergency fund covers him for 12 months.
If John went with the generally recommended 6 months of emergency fund, he would have $12,000 to invest. If John invested that $12,000 and earned 5% per year, each year he would earn $600. In comparison, John would only earn 2% or $240 a year, if he invested that money safely in cash. Therefore, we can say that John’s opportunity cost of having a large emergency fund is $360 a year for John.
In my opinion, that’s a small amount to pay for peace of mind and a better chance of increasing his largest source of income.
What do you think?
Photo by: The U.S. Army