How to Invest Your Emergency Fund

Mike: [00:00:00] Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton, a financial counselor and financial advisor. And today, back on the show is our good friend Julie. Good morning.

Julie: [00:00:13] good morning, Mike, how are you doing

Mike: [00:00:15] good.

How are you

Julie: [00:00:16] good.

Mike: [00:00:17] Rain has stopped outside, which I thought I would have a lot of background noise of rain pounding. But I think we've avoided that.

Julie: [00:00:25] I know, I thought so too, but that it's new England, so that could change momentarily.

Mike: [00:00:30] That's right. Just wait another hour. Now today's topic. I'm pretty excited to chat through with you because you hear a lot of generic information about this, and I'd like to really give our listeners a concrete way to think about this. And we are talking about emergency funds. So Julie emergency funds, what does that make you think of?

Julie: [00:00:51] So this is a really great topic. I've been hearing it in the news lately, too. And it's make sure you have six months of income stored somewhere. And I have a lot of questions stored under my mattress in a bank, in a savings account, where should I put this money? How do I go about figuring out what that dollar amount is?

Mike: [00:01:14] Okay.

Julie: [00:01:15] And at what point. Do we change the amount in the emergency fund? Or does this money just sit forever? tell me more, Mike.

Mike: [00:01:28] exactly. They always tell you that's right. I read this everywhere three to six months of expenses in your emergency. And then some fluff about whatever that means. So let's get into it today and really try to nail it down. Should it be three months? Should it be six months and where should it be and how to think about it?

Now, the first thing, when I think about emergency funds is this is for a true emergency and unexpected. Expense. This is not for things that we know are going to happen. All right. So some things are irregular, but we still know they're going to happen. So maintenance on some of your appliances.

Something's going to break. Okay. We don't know when, but we know there's upkeep on the house that needs to happen even so far as a new roof. Super expensive. But, in 30 years or however old your roof is, you're going to need a new one. You can budget and plan for those types of things.

So the emergency funds are really for the unexpected, which could be a loss of a job. That's the big one. Hey, what if I lose my job and I don't have income for awhile. Okay. That's unexpected. It could be health emergency. Maybe you're in an accident. You can't work for a little bit. Maybe a family member is going through something you got to so take some time off work that you were not expecting.

So they mostly work related, but treat the emergency fund as a true emergency. The other stuff, the home upkeep, the roof, you're going to know you're going to need this and that have a budget for those. All right. So those are in the budget. So that's the first starting point.

Julie: [00:03:05] Famous saying in the army, they used to say lack of proper planning does not constitute an emergency

Mike: [00:03:12] That's awesome. That's it perfect. lack of proper planning It does not constitute an emergency

So that's the first thing. and so not all the articles will talk about that, but I want this to be a true emergency fund. I don't ever want you to tap this. It's a small probability that you're going to tap this money. Everything else is in the budget. It's in the plan. So how do we get to how much it should be? Should it be three months of expenses, six months of expenses. Let's get a little more accurate on how much it should be.

Julie: [00:03:40] and what are those expenses?

Mike: [00:03:42] and what are those expenses are perfect. So the first is how do we nail the accuracy?

If your job, this is really around job loss, or having to take a break from your job. So if your job is very stable, It's not really tied to the economy so much, there's always demand for your job Or not maybe this particular job, but there's, and for your field, you can easily get another job.

Recruiters are always calling you then you can go down to zero one month, two months, you know that you could pick up another, very unlikely you lose your job. And even if you do, you could pick up another job very easily. All right. So then I would say, look, have one month, maybe two.

of expenses. If however, your job is very unstable, it's very much tied to the economy or you're an entrepreneur.

You never know what's going to happen next. That's right. And then the other thing is maybe your salary really jumps around. So a lot of sales positions would be in that category.

You're not really sure you get a year end bonus. You're not sure what month to month. So those you might want to get to more of that stuff. Of savings of expenses. All right. So now we've dialed in. Okay. Get a little more accurate around where you need to be for your situation. Now, what are those expenses?

The expenses are the required expenses that you have to live on.

Julie: [00:04:58] mortgage groceries, car payments,

tuition.

Mike: [00:05:02] Yeah, exactly. The things that you can't get rid of. All right. So do a quick, like back of the end. On those things. Oh I wouldn't be traveling, wouldn't be dining out, get my everyday coffee. I wouldn't be eating lunch out cause I'm not going to the office or whatever those things are.

And really dial it back to what you actually have to spend. And those are your expenses, monthly expenses times the number of months that's the total dollars you're looking at.

Julie: [00:05:26] so let's just make sure, because a lot of people get overwhelmed or they there's a big area. They tend to forget to include in their expenses. So I mentioned, mortgage, car payments, groceries, tuition bills. What other utilities, what else is a required expense?

Mike: [00:05:42] Utilities or rent. You can quickly look at the things that you have to do each month, but those are the big ones. It's really your living expenses. So whether you're renting or your mortgage and then dining, eating, you gotta eat food for you and your family.

And then yeah, tuition bills. I can't really think of anything else off the

Julie: [00:05:58] How about health care? That would be something. If you lost your job, you'd have to go on private health care. So that would be something to line item there.

Mike: [00:06:06] Yup. Private healthcare. Now you can get Cobra insurance when you lose your job, you can get continuation, but you're responsible for that.

Julie: [00:06:13] And it's expensive.

So

it's something you should include in there.

Mike: [00:06:16] Yep. Especially if you got family. So yeah, definitely total that up. And like you said, car payments and all that would be in there.

As a non discretion.

Expenses now next, where are we going to keep this money? Julie? She just

Julie: [00:06:31] Under my mattress,

Mike: [00:06:32] the mattress,

Yeah. Put those couple thousand dollars under the mattress.

Julie: [00:06:37] as crazy as that, I'd laugh and joke about it, but I have a friend who recently told me that when COVID first hit, he. A lot of money out of the bank and literally put it under his mattress. And I looked at him like, are you insane? And he said, no. I didn't know what was going to happen when the pandemic hit.

And I didn't want to be in a place where I had no access to my money.

Mike: [00:07:00] Hopefully I had rolls of toilet paper as well.

Julie: [00:07:03] I'm sure he did. He also had oxygen tanks, so

Mike: [00:07:08] That was great.

Julie: [00:07:09] true emergency planning.

Mike: [00:07:10] So I don't recommend under the mattress. We do need this money to be very liquid. And what I mean by that is that you can have it available within a couple of. All right. So we don't want it stored somewhere that you cannot get it within a couple of days. So that could be checking or savings account.

It could be on a brokerage account in your money market account. It could even be in stocks and bonds. I'll talk about that in a minute. You could sell those and get them back within three days. And so that money is there. It could be in CDs. Now, CDs are locked up get a six month CD or one year or two years, but you can always get the money back out.

You just pay a small Penalty So even if you had a one year CD to get a little more interest, if you really need that money, you can get it back out. Now, remember that I've defined the emergency fund, not for the appliance and the home upkeep and the other stuff. It's a true emergency. I hope you never have to tap this so therefore we can have it invested a little. I'm going to say, quote, unquote riskier. Okay. We want to invest it for the future a little bit more because we hope to never have to use it. So I really don't want that money sitting there in cash. So if you said, geez, I'm living a pretty decent lifestyle. Maybe my expenses are five, 8,000 a month and I need three or four months, you know, 30 or $40,000.

You might want to have available. That's quite a lot of money that we don't want sitting just in a savings or checking account. For the next 20, 30 years, cause you were hoping to never ever use it. All right. So we can have it in those kinds of places. The one area I will really recommend is a Roth.

IRA is a great place for storing this money. And the reason the Roth IRA is great is because we hope to never have to tap it so it can stay in there forever and we could invest it and talk about that in a second. But also you can take back out your contributions at any time from the Roth IRA. So if you do a $6,000 contribution this year, another 6,000 next year, and then you have an emergency, you could take out up to $12,000 out of that Roth IRA and spend that money

Julie: [00:09:09] Penalty free.

Mike: [00:09:10] yep.

Tax-free. And penalty-free your contributions to the Roth IRA. You can always take those back out.

Julie: [00:09:16] Is that because your contribution went in? Post-tax

Mike: [00:09:20] Yep. That's correct. You've already paid tax on it. That's right. So that's a great place to park your emergency funds now. Not all of them because you really don't want to take money out of there. okay.

But again, this is basically an insurance, a self-insurance little policy

Julie: [00:09:37] well, there's limits every year as to how much you can put in. Okay.

Mike: [00:09:40] There's limits to how much you can put in every year. That's why I don't really want you taking the money out now again, since it's a very small chance that you're going to use this money, let's get it in there. And if you have to use it, Hey, you had to use it for an emergency. That's fine. But the reason why I'd prefer you not to take it out, if you can avoid it is to that point, Julie, there's only so much we can get in every year.

So once it's in there, you want to be very careful about taking it back out.

Julie: [00:10:04] but it sounds like what you recommend. So for instance, if you need a $30,000 emergency fund for this year in particular, you can only get what's the cap on a

Mike: [00:10:13] six, 6,000. or 7,000. If you're over.

Julie: [00:10:16] Okay. So you can only get 6,000 of that in there. Where do you put the rest?

Mike: [00:10:22] Oh, yeah, you can just leave the rest of the brokers. What I'm saying is over time, as you've built up that 30 or 40,000, you can do 6,000 every year. So now if your Roth IRA balance is that 30 or 40,000 at this point, that could be your emergency savings. It could all be in there. now, , if you want to, I had that amount and you can't get it all on the Roth.

Yeah. Just keep it in your brokerage account. Money market accounts would be a great place to be. Now that leads me to how to, how else to invest this. Of course we want it to be liquid. We don't really want to go down in value. We can't say, look, I need 30,000. In emergency expenses and then two months from now, oh, geez, I had that emergency and now it's only worth 20,000, so that would be bad.

So we'd really don't want it going down in value that said we hope to never use it. So what you can do is invest it into a low cost index fund portfolio. And if you have the means, so this is if you have the means to that, you have good enough income and you can save every month. If the portfolio is down.

So your emergency fund drops from 30,000 to 28,000 or 25,000. Can you start building it back up quickly by continuing to invest, if you can, then that's a great way of doing that. So again, that you're invested for the future, hoping to never to use this emergency fund, but you still have the amount of funds that you.

Julie: [00:11:41] now, what would your recommendation be to folks who let's say their emergency fund for six months would equate maybe $10,000. And so they're listening to this thing. Oh, 36. But even to save 10 might take me three years. What if I have an emergency in six months, what do you recommend in terms of how to start saving for that emergency fund and what percentage of your income should go into that fund?

And how do you get there quickly enough that you can have peace of mind?

Mike: [00:12:19] Yeah. Let's take a couple of different angles. Let's start with that. That scenario where, geez. Yeah, I want to six months I've unstable job or really six months. I need $10,000. I'm starting from nothing right now, starting to save. Just start. If it's going to take you two or three or four years to get to 10,000, That's fine.

Just get started. That's the best thing to do? What percent, if you're young or any age, really 10 to 15%. I'd love for everybody to be able to save more than 10% of their income into retirement education, emergency savings, across the board. Really push that. If you're not at 10%, just get to 10%.

If you're at 10%, try to get to 15% over time. You could do that by either just, every six months at a percent, or whenever you get a raise, once a year you get a raise, put 50% of your raise towards savings, 401ks, IRAs, emergency funds, like across. Once you get to that 15%. And if you could start there when you're young 15%, that is fantastic.

That's what you want to do. Now. Don't get discouraged by not having an emergency savings and wanting to start, just get started, whether it's 50 bucks a month, 200 bucks a month, whatever you can do and just put it away. Now, if you're in that situation, you're just getting started. I do want that in checking savings or money market, don't invest it anywhere.

You don't want it to drop in value. You don't want to get hooked on the investing side of things. Just start saving the money. That's the important part. Now at the other end of the spectrum was more I was talking about because I see a lot people that have come to me and say, wow, I've got a hundred thousand or 200,000 in cash.

Like I need to get that invested. Cause they've been saving, they've been doing a good job and grown, cause they have very good incomes. And so that's kinda where I'm saying. If you're in this situation that you have good incomes, you're saving into your retirement accounts and you've got this 30,000 or 40,000 for emergency.

You can really treat the overall portfolio as emergency funds. You don't need just 50,000 sitting in cash, having a drag on your portfolio, not making any interest you can easily afford to, even if the market's down and you lose a job, you can still sell $20,000 of stuff and, spend it on that emergency and bridge the gap until your next.

Julie: [00:14:38] That's. Yeah, that's really cool.

Mike: [00:14:40] Yeah. So because the news out there and the articles are all like, Hey, three to six months and just save it in checking savings. You can't have it go down a value or invest it. And once you get to a certain point, I don't think that's really true. I think that you can have an invested, understanding your risk tolerance, and that if the markets do go down, you're going to have to sell some of those bonds.

And do you know, fond that emergency. If you have something to come up.

Julie: [00:15:05] So don't put your emergency fund in Bitcoin.

Mike: [00:15:09] I don't want your emergency for the Bitcoin. So yeah, this is the thing. It's a good one. So what I did say, if you noticed is if you had earmarked say 30,000 for your emergency fund if it goes down, you have to quickly. To get back to the 30,000, so sure you can put it in Bitcoin.

but if it goes down to 10,000, then you're going to have to come up with another 20,000 very quickly to build up your emergency fund.

So, No, I wouldn't get too aggressive in that

Julie: [00:15:36] yes, something safer like a Roth IRA.

Mike: [00:15:40] That's right. That's right. All right. Anything that we haven't covered?

Julie: [00:15:44] No. Oh, just because it's my favorite account is an HSA also a good place to keep some emergency funds.

Mike: [00:15:52] HSA is not a good place to keep emergency funds.

because you can't get the money back out without paying penalties.

Julie: [00:15:58] What if you had receipts for

Mike: [00:16:01] oh, I see what you're saying. Our favorite strategy of having it with the receipts. So what you do is you have an HSA account. You're putting the money in, you are spending out of pocket. For your medical expenses and saving the receipts. So yeah, Julia, in that case, you could do that. And so that would be fine.

And so if you'd built up 10 that you'd have to build up, $10,000 of receipts, to be able to pull that out quickly. But you could definitely do that. The Roth IRA is just way easier. If you're saving the HSA, you should be saving first to the Roth. I would fund a Roth account ahead of the HSA only slightly ahead.

They both have great tax benefits. And so I would just say, use the Roth instead.

Julie: [00:16:38] Save the HSA for retirement.

Mike: [00:16:39] Yeah.

Julie: [00:16:40] Good.

Mike: [00:16:40] All right. Super. Hopefully that gives a little bit more targeted guidance on the emergency funds and how to think about them, how to use them.

Julie: [00:16:47] I think it was a great story.

Mike: [00:16:50] All right, Julie, we'll catch you next time.

Julie: [00:16:52] Thanks so much.

Mike:Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at . Until next time thanks for tuning in.