Building an emergency fund is a core piece of your financial well-being, as having a solid emergency fund gives you the peace of mind and confidence needed to take on more ambitious financial goals.
Coming from a poorer background, I have experienced firsthand the stresses of having little to no emergency funds. Throughout my investment and professional career, I have made it a goal to be able to handle various financial shocks. To meet this goal, I maintain 7 to 12-months worth of financial reserves.
Now, I know this may seem excessive and unproductive, but read along to see how I approach this topic, and maybe you’ll pick up some ideas for yourself. Alternatively, if you are not sold on having an emergency fund, or you want to learn how to get started I recommend reading my post here that introduces the topic and helps you develop a plan of action.
My approach to Emergency Funds
I take a bit of an unorthodox approach, that borrows ideas from other areas of personal finance and allows me to have 7 to 12-months worth of savings. This is not for everyone, and this is not financial advice, I am simply sharing how I address this topic.
I borrow from the concept of a CD or bond ladder approach, where one creates a portfolio of fixed income holdings with different maturity dates. For example, you might have 3-month, 6-month, and 12-month CDs and roll the funds out as the CDs mature. Instead of opening CD accounts or buying bonds, I have the concept of ‘risk buckets’. Each bucket of money has different risk and expected return levels and different anticipated timelines.
- No-Risk: This is my high yield online savings account, where I keep 1-2 months of savings. This is money that I need access to ASAP, and I cannot wait. Money enter’s this account first.
- Low-Risk: This is a low-risk portfolio composed of 40% stocks, 45% bonds, and 15% gold that has an annual expected return of 7.7% with an annual standard deviation of 7%. I keep 4 to 6 months of savings invested. This is money to be tapped only after the previous bucket is depleted, and if possible not all at once. In March 2020, it was down 8%.
- Moderate-Risk: Portfolio split between ETFs invested in a basket of global stocks and bonds with an annual expected return of 8.9% and annual volatility of 10.8%. I keep an additional 2 to 4 months of savings invested. This is extra savings, to help provide additional peace of mind. In March 2020, it was down 14%.
As each bucket approaches its monthly savings target, I withdraw money and move it to the next risk level bucket that requires funding. For example, if my no-risk bucket hits 2-months or more worth of savings, I move some of the money into the low or moderate risk buckets, whichever is furthest from its max target.
Alternatively, market conditions can also impact the flow of funds from one bucket to another. In March 2020, my low-risk and moderate-risk buckets were down while my no-risk bucket was at capacity. Market conditions warranted moving money from the no-risk directly to the moderate-risk bucket.
In total, I can have up to 1-years worth of savings, but it’s structured in such a way that the funds are not sitting idle and are instead working for me, and together they can work to meet my liquidity needs if ever needed and help with my overall long term financial goals. Once all risk buckets are full, I either divert future deposits to my more aggressive investment accounts or I’ll make withdraws from the highest risk buckets; with the funds being invested in more aggressive portfolios.
Conclusion
As mentioned earlier, this is my very unusual approach to emergency savings that allows me to meet my goals of fortifying myself from financial shocks while at the same time actively helping me meet my long-term financial goals. This approach is not for everyone and though it does not follow the traditional approach to emergency savings, I hope this post helps you determine what works best for you and helps you get started to take action.
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