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The New Emergency Fund: Five Components of an Emergency Plan

In an world of overly simplified platitudes and one-size-fits-all “advice,” there is little repeated more in personal finance than the importance of the emergency fund. Typical popular financial advice prescribes a high-yield savings account in which one can store three to six months’ worth of expenses. Suze Orman suggests aiming for eight months’ expenses in a savings account. David Bach believes four months is a good starting point for an emergency fund.

Advice for a fat emergency fund sounds good when high-yield savings accounts are actually providing high yields. When interest rates are low, it can be financially detrimental to leave so much cash uninvested. It may be worthwhile to diversify. Rather than having just an “Emergency Fund,” like a “subaccount” at ING Direct with its own name, this can be only one component of a larger scheme. To encompass all that could be included, perhaps “Emergency Plan” is a better term than “Emergency Fund.”

I am not talking about a box that you keep in the trunk of your car that contains a gas mask, a gallon of water, a hand-crank radio, and a can opener, like one of my coworkers. While that might be helpful for the Y2K bug when airplanes fall out of the sky in midflight, this “Emergency Plan” refers to finances only. There are five components.

1. Mattress cash stash. Obviously not hidden beneath your mattress, having some cash in the house — hidden in a weird place that a burglar would not think to look — gives you access to fast cash if you need to leave right away without any time to stop at a cash machine. Also, if the ATM network is down for some reason, you won’t have any trouble trying to access some money. It would be impossible to predict how much you would need before you could access the banking system in a catastrophic event, so I think the guideline here is just to be reasonable. Maybe keep a couple hundred dollars in cash around the house.

Of course, in the worst situation imaginable, money itself would lose all value and society would be reduced to a system of bartering for what you need. Even gold, which some people claim has intrinsic value that paper money does not (it doesn’t), could be worthless. Don’t bother keeping bars of gold around. The idea is to prepare within reason. Keep this amount as low as possible; money sitting around loses value relative to the things you would need to trade it for thanks to inflation of the money supply.

liquid2. Liquid account. Unless the banking system fails, you should be able to access your next level of emergency fund within 24 hours. With interest rates decreasing every week, it might make sense to seek out better paying liquid investments like money market funds. All of the cash I have earmarked for emergencies, about $10,000 right now, is held at ING Direct, currently one of the lowest of the “high-yield” savings accounts.

It wouldn’t hurt to add layers to this level. This year, I will change my Emergency Plan to leave cash in the amount of expenses for one month or less at ING Direct while increasing my savings at a money market fund that beats inflation like the Vanguard Prime Money Market Fund, currently earning a 4.55% yield. Between my mattress stash and liquid accounts, I want to be able to cover three months’ worth of my current expenses. That’s a little lower than what’s recommended by the gurus, but I chose this amount because the chance of losing both of my sources of income at the same time is low and I believe I could find a new job quickly if necessary.

Bankrate discusses using certificates of deposit or bond funds for this portion of liquid savings, but they are not liquid enough. The interest premium offered over high-yield savings accounts and money market funds, usually small, won’t outweigh the chance of paying an interest penalty for early withdrawal before maturity.

3. Investments. With investments, we’re starting to get into the territory of the money you’d be better of not touching, even in an emergency. The Roth IRA is the first stop if you need to tap your investments in an emergency. You can withdraw your contributions (not your earnings) without penalty, taxes, or fees (depending on your broker). Once the emergency condition has subsided, you can still contribute the money you withdrew back into your Roth IRA.

If you don’t have a Roth IRA, you may have to turn to taxable investments. This isn’t a great option, but still better than the next. If you have to sell when you’re investments are down, you’re not doing yourself a favor down the road. You may get some tax benefits in this case, but you’ll have to determine whether it’s worthwhile. If you sell your investments while they’re higher than they were when purchased, you will owe taxes, which could be just as troubling in the short term if you’re still in an emergency condition. Either way, you’ll also contend with transaction fees.

Stay away from granting yourself a loan from your 401(k). If you lose your job during this emergency, your 401(k) loan will become due immediately. That’s an unaccessible level of risk, at least for me.

cheerful credit4. Credit. This is a slippery slope. Some recommend using a home equity line of credit as an emergency fund but having a HELOC in the first place means having an interest expense every month. The purpose of a HELOC goes beyond emergency funds, and therefore shouldn’t be the only part of an Emergency Plan.

Credit cards should be avoided in most cases. They could be used most effectively when you know that the emergency condition will subside before your credit bill comes due. Interest charged for credit card accounts is usually way too high for effective emergency use. If you have a special promotion with your credit card, like 0% APR on purchases or cash advances, then taking advantage of these deals could pay off. It requires extra special attention to make sure you don’t fall into any of the credit card traps. If you end up owing back interest due to a late payment, even in an emergency situation, you could be paying for this emergency longer than you would otherwise.

5. Friends and family. While I originally thought this fifth component is outside of one’s control, if you’ve done a good job of taking care of the universe around you, the universe will return the favor when you’re in need. If you’ve made a habit of helping those in need when you were able, when you’re in need, perhaps someone will be there to look out for you. Perhaps this will be in the form of your roommate or friend lending money to you at a very low rate or a gift from your parents. Either way, it’s best not to rely on help from the universe, as there are no guarantees. When you save cash in a money market fund, it’s guaranteed to be there when you need it. Friends and family can provide powerful assistance, but if you don’t need it, don’t take it.

Here’s a secret. There are actually six components.

6. Reduce your expenses. One thing you can do to make your Emergency Fund last longer, or save more for next time, is reduce your expenses temporarily. Make some sacrifices, like the Expensive Coffee-Relate Drink, cable television, or weekly dining engagements. Desperate times call for desperate measures. Feel free to indulge again once you find a new job or otherwise increase your cash flow to normal conditions.

What is your Emergency Plan? Do you consider yourself covered with cash in a savings account, or do you take a more complete approach?

Image credits: tanakawho, ChicagoEye

Updated June 24, 2016 and originally published January 29, 2008.

About the author

Luke Landes is the founder of shizennougyou. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 11 comments… read them below or add one }

avatar 1 Anonymous

Could also include a food storage in that plan. Not only is it good to have one in case a real disaster strikes, but it is also possible to free up so money by digging into the emergency food. Of course better hope that a real disaster doesn’t happen during this time.

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avatar 2 Anonymous

I think that food storage is a good idea. I came to the revelation at Christmas time when we were spending money on gifts and cut way back on groceries. The food that we already had stored lasted a very long time and we just rebuilt our stock after the holidays.

If you have two months worth of food staples that is two months where you will have little to no food bill.

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avatar 3 Anonymous

If you withdraw from Roth IRA, even if you put the money back in, you essentially decrease a given year’s contribution limit.

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avatar 4 Luke Landes

Thanks for sharing the food storage idea, ERE. That’s a great way to plan ahead to reduce your expense during an income emergency. Also, it reminds me that I need to shop for groceries.

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avatar 5 Anonymous

I like the idea of an Emergency PLAN. As interest rates have fallen, I’ve found myself contemplating a more aggressive plan. But I’m also quite conservative and risk-averse (it’s my nature coupled with the fact that I have two young kids to look out for), so I’m hesitant to branch out past our banks savings right now. I’m thinking about all of the alternatives, though.

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avatar 6 Anonymous

Isn’t the point of an emergency plan not necessarily to earn you income, but to be there when needed? As long as your savings account can keep pace with inflation, is it really necessary to try to make money off of it?

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avatar 7 Anonymous

Well, I’ve been trying hard to make an emergency fund, and so far am far, far short of the experts’ recommendations. But these are interesting things to think about. I do have the stockpile of food going- we could live for about two weeks on what we have, and I’m trying to build this up as well.

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avatar 8 Anonymous

If you’re really thinking of “the worst situation imaginable,” in which “money itself would lose all value and society would be reduced to a system of bartering for what you need,” then it would make sense to build a stockpile of highly barterable, possibly contraband goods: cigarettes, alcohol, and dope. Stash all the prescription drugs you can get your hands on; buy some cigarettes, package them air-tight and store them in the freezer; cache a case or two of vodka in the back of a closet. These items, plus (possibly) what you can raise in a backyard garden (assuming you can keep the neighbors out) would be useful in an extreme emergency. Ditto guns and ammunition.

Personally, I have a hard time working myself up to thinking in such off-the-wall terms. In the present times, I’m all for money market funds–Vanguard Prime Money Market is good–and maybe having a small stash of actual dollars hidden somewhere in the house. And, depending on where you live, a week or so of emergency provisions (food, propane, batteries, etc.).

My mind could be changed, of course…but so far, I’m not that scared.

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avatar 9 Anonymous

I have an emergency fund with the several layers you mentioned. I also keep a well-stocked pantry, but I never thought of it as a part of my emergency financial plan before… I just like to cook. Come to think of it, though, a filled pantry helps me save money, too. I buy storable food (dry or canned) when it’s on sale and use it as needed. This helps me keep my costs lower- which gives me more $ for my emergency fund.

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avatar 10 tbork84

I didn’t ever think of a stocked pantry as a layer of my emergency plan either, but it is a very valid point.

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avatar 11 Anonymous

What about insurance? So many people don’t bother to get adequate insurance or to write a will (who would take on the long-term commitment and expense of taking care your kids if you could no longer work, get very ill, or even die?). Does anybody think that flood ins. would be a bad investment? I live in a very low-laying state with wetlands in my backyard. Even though it’s not considered a flood-prone area, you all know what’s happening in ND right now. Besides, I remember a hurricane hitting my area back in 2003 (power was out for 4 days) and another major storm in 2004. After that, we invested $400 in a portable generator and it has come in handy.

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