Everybody will agree that you having an emergency funds is something you definitely need to have. But how much you should put into it is a lot trickier.
The reason to have one is simple: having readily available cash can solve a lot of problems. Life in general is bumpy and even if you live a pretty frugal life you will, from time to time, be confronted by unexpected costs. It is never fun to have to shell out a couple of thousand euro’s to replace something that was working fine JUST 5 MINUTES AGO!! But even less fun is having something break down and not having the money to fix it. And some things need fixing immediately. Having only cold water to shower with is an ‘adventure’ when you are a 20 year old student (you are young, tough and do not mind having an excuse to go take a shower at that attractive friend of a friends place, since she happens to be staying in Ghent during the Christmas holidays as well …). But as a 43 year old I prefer to have enough funds to have this fixed immediately.
The size of your emergency fund, that is an entirely other matter. There are so many variables that determine the best size of an emergency fund that a one size fit all approach does not work.
Some reasons are very tangible: if you own a house you will need a lager emergency fund than when you rent because you have a bigger change of being confronted with unexpected costs. Some are psychological: you may find it a very reassuring thought to have a bucket full of cash at the ready.
So I will not be telling you how much money you should put into your emergency fund. I will tell you my thoughts and how they evolved.
You see, I was one of those people who liked a decent emergency fund mainly because of psychological reasons. I liked having buffers. Buffer one was my checking account. I liked to keep that at 2.000 euro. And that Is at the end of the month, NOT the beginning. So yes, it frequently shot up to 4.000 euro at the beginning of a month.
Buffer two consisted of my savings account where I liked to have 10.000 euro in it (this was as somebody who rented and did not have car).
And then there were my investments.
This three layered approach meant I was a financial rock! Life would have to be pretty creative to get me into financial trouble!
Looking back at it I blame my mother. Yes, I know, therapists always blame the mother but in this case he/she would be spot on! It’s my mother who manages the finances at my parents and she is a big believer of healthy cash buffers. Well, it’s more unhealthy cash buffers in her case as they frequently end up with 6.000 euro on the checking account! And the cash in their saving accounts … As an active investor making pretty decent returns for the last 17 years, it can be maddening thinking about their missed returns …
But in all honesty, I can’t really blame my mother. First off, she probably picked this behavior up from her mother and secondly, saving and putting money on the side is a good start!
But what is missing is a clear vision, goal on what to do with the excess cash. This is something most people do not have. How else do you explain that we Belgians have 365 billion (BILLION!!) euro on savings accounts (and with interest at 0,11% and inflation close to 2%, actually losing purchasing power each and every year!). With 8,6 million adults not living in poverty in Belgium this would mean an average cash amount of 42.000 euro per person. A bit much for it to be an emergency fund and some savings. Clearly, we Belgians keep to much cash. The newspaper De Tijd currently even has a special segment for it: van spaarder tot belegger.
Hell I myself only started investing because I like numbers and looking at companies. I had no clear plan! Sure, when the stash grew bigger you start thinking that maybe, someday you perhaps could live off dividends. But this was a vague idea. Not a concrete goal that seemed achievable.
It was the FIRE community that brought me that clarity and thus also had an impact on how I look at the emergency fund.
Now my emergency fund is truly an emergency fund, only to help with unexpected costs and not to provide some psychological safety feeling. I have to admit I am not yet fully cured as I still prefer to have 2.000 euro in my checking account (damit Mom!). But in general I want my money to work as hard as possible for me, not sit idly in a savings account losing purchasing power.
Because I keep a budget now I also have a better view on my expenses. Being frugal means that most of my stuff costs less, hence takes less money to replace (a washing machine is 200 euro used, not 600 euro new, a car max 8.000 euro, and so on …). Since I also save a nice portion of my income each month I also need less funds to cover a period of reduced income as there is a nice savings buffer that will take the first hit.
I also believe that the bigger your stash is, the smaller your emergency fund can be. Perhaps it is because I am an active investor but I know I will always be able to have my stash produce some cash flow. The bigger the stash is the easier this becomes. Sure, this will take a bit of time (perhaps even a week or two) but it also means your stash does not need to cover six months of living expenses. If you have regular option premium income or dividend income you definitely can reduce the size of your emergency fund.
All the above has helped me a lot in determining the right size of my own emergency fund. It used to be 10.000 euro even if I was renting and had no car. But even with a house, a car (and a Vespa) now I have put the size of my emergency fund to 6.000 euro.
The same amount for my girlfriend means we have 12.000 euro which would be more than enough to replace a broken car AND something in the house at the same time. Or cover a nice period of reduced income (the Belgian social security system does also help in case of unemployment or sickness).
As I said in the beginning. The size of your emergency fund is something personal and there are a lot of variables at work. But I have come to the realization that for us FIRE people conventional wisdom does not apply. Then again, isn’t conventional wisdom wrong for a lot of things?