Tuesday, July 26, 2011

Do I need an emergency fund?

Right now my best estimates put me within striking distance of being able to achieve my goal over the next two years.  There are some big assumptions in there: a budget of $800/month living expenses, working full time until school starts and successfully getting paid at the same withholding rate as my last check, not owing a big tax bill, my school doesn't reduce my financial aid and that I'll get a paying internship next summer that pays about average for my school. With all of those assumptions plugged in, I'll be $100 short of meeting my goal.  That number isn't at all meaningful, of course, aside from telling me that it's possible to meet my goal but it'll be close, because there are so many assumptions playing into it at this point.

But that $100 gap assumes I use all of my liquid savings and 529 balance. In other words, my checking account would be empty, I'd have no non-retirement savings and no buffer and I'd be about $100 short just before graduation.  I'm actually really happy with that answer right now; it's way closer than I thought I would get when I originally set my goal.  However, now I'm wondering how close I can actually cut it.

I've never had a true emergency fund, per se, but I've always had enough liquid savings on hand to cover a new (to me) car, a year's worth of living expenses or more.  Now all of that has been earmarked for tuition, living expenses and so on and will very rapidly disappear.  This year I'm less concerned for;  I have enough in cash right now to pay all my living expenses plus a six-month buffer even after paying for my tuition, fees and supplies.  That buffer will, hopefully, grow through the end of this summer as I continue to work and be paid.

Next year, however, is a different story.  From my best estimates, I'll pay my business school bills and have just enough left over to cover expected living expenses and not a dime more.  No emergency fund, no slush fund of savings, nothing.  So I'm wondering how I should approach this and thought it would be better to come up with some strategies now, while I still have savings and options, rather than later when I'm already down to minimal to meet expenses.

I do have a few options, but I'm not sure which is best:
  1. Wing it - It's in the future, I have family, friends and a SO who can help me out and who knows what will happen between now and then (This option terrifies me more than a little. Neurotic planner, who me?)
  2. Loans - I could accept enough loans to constitute an acceptable emergency fund but not take distributions unless I'm in a real bind.  
  3. Roth IRA - I have about two years worth of living expenses in a roth IRA that I'm currently planning not to touch.  I'd like to avoid dipping into them since you can't put the contributions back later.
  4. Something else?  - I currently have no plans to work, I could set up a formal loan arrangement with an interest rate with my SO, or some other plan.  You guys have any ideas?
 So I'm looking for any feedback or ideas for all you smart readers and bloggers out there on how to approach this.  I'm kind of drawing blanks on how to decide.

Of course I also need to figure out what size of emergency fund is appropriate for my situation.  Here are some factors:
  1. I have good health insurance
  2. I'm not planning on making money while in school, though I might take a job if it was a good fit
  3. I won't have dental dental insurance 
  4. My SO will continue to work and has a separate and large savings slush fund, but we maintain separate finances and I would like to do this on my own.
  5. Cash on hand when I apply for financial aid again this spring might ding my financial aid for next year
  6. My fixed costs are very low once the business school bills are paid.  Rent is $400 plus utilities and groceries are $12.50 a week for my share and that's about it.  (Thank you mom and dad for the family cell phone plan and car insurance.)  Realistically irregular expenses and utilities will keep my minimum spending above $500 a month but I might be able to get down to $600 in a crunch situation.
 So, all my wonderful personal finance gurus and amazingly opinionated readers, tell me what I should do!

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  1. I think every person needs to evaluate this differently. I have a dedicated emergency fund, but sometimes I wonder if this is overkill, because I also have separate funds for things like a new car, home renovations and such. All of those 'funds' could be tapped in the event of an emergency and most likely I wouldn't be buying a new car in the event of an emergency, anyways, so I wonder if I'm keeping too much cash on hands. In the end, though, I am more comfortable that way as I'm pretty fiscally conservative. It just depends on your level of comfort, I guess!

  2. I agree with Money Beagle. I think it depends on your other assets and account. We also have an emergency fund but this is only because we haven't established our other savings to the point where we feel like we can get rid of it. It is nice to have the extra security though.

  3. My favorite approach is on the list, winging it.

    Wing it, man. Things will work out fine, and it'd be better to spend the energy on what matters (getting the most out of your studies) than planning for failure.

    Do you have open credit lines? Maybe you could hit up a CC for a large balance transfer check at near-zero rates. Worst that happens is that you borrow a lot of money inexpensively at a rate that won't make you broke. If that's your worst case scenario, then you're doing just fine.

  4. I would consider option number 2. I would assume that these are school loans which might represent a decent interest rate (much better than a credit card if you were in a bind). If you make it through without needing them, great. If you even take the money to pay tuition and use your funds to pay it off at the end of the year, you might still get by with no debt or a few thousand at most.

  5. Are your student loans subsidized? If so take them! Take the first semesters loan, stick in a high yield savings or checking and let it earn interest for you. Then a few months after you graduate, pay the sucker off and pay no interest.

  6. Frugal Student - I qualified for Subsidized Stafford loans but they're capped at $8,500 per year and have a 1% origination fee. I'd make a little over $100 over two years by putting the money in a savings account. Even a two year CD can't boost earnings to more than $200 since interest rates are so low. With that little reward it just didn't seem like it would be worth the effort and paperwork. Plus there's always the chance I'd spend it all ;)

  7. I go with a combination of 1 and 2. You apply for the loans, wing it, and if you need the money, you dip into the loan money.

    I had to charge tuition on a credit card when I was in graduate school because I couldn't get anymore loans, and I didn't have enough to pay tuition, even though I worked during school and every break. You are doing great as it is, and there is nothing wrong with providing a little breathing room for yourself.

  8. I would go with accepting the student loans but not cashing them out unless you need to. Also, you could try to monetize your blog to make a little side money.

  9. Thanks for the advice everyone, and feel free to keep it coming. I've declined all loans for this year since I'll have cash on hand, but next year I may accept the subsidized Stafford portion ($8,500) and not have them disbursed unless it's an emergency.

    Everyday Tips - Tuition on a credit card sounds brutal! How much interest did it accrue before you could pay it off?

    Mom's Plans - Any monetization advice is welcome. I just slapped Ad sense up as a place holder ;) So far it's paid for my domain!

    cashflowmantra - I agree that student loans would be better than credit cards. Don't think I could get a 0% balance transfer with less than a 1% fee and interest rate of less than 6.9% after one year which is what it would take to be better than the subsidized Stafford loan.

  10. Could you structure a low interest loan with your parents? When you are making the big bucks, you'll repay with a nice interest rate which they would not get in a bank. Everyone wins!

  11. Buck Inspire - I like this approach and my SO and I have talked a little about setting something like that up if need be. It's nice to keep the money in the family.

  12. I would definitely go with option two. If you have the discipline to budget all of this out, take the loans and keep them segregated. After you become gainfully employed, pay off the loans.

  13. Selling Theta - I'm still considering this option, but since congress just slashed all subsidized loans for grad students it's looking less appealing. Still better than a credit card though.

  14. I was reading a book written by a guy who went to HBS for his MBA who came from a poor blue-collar working class family (i.e. they had no money to subsidize him). That said, he was in a similar boat as you are. One of the things he did was he and a couple of his classmates started a low-cost consulting firm and hired themselves out on the cheap (compared to say Deloitte) to small businesses who couldn't afford big fees. This gave him a chance to network, get experience in multiple industries, reinforce his learning by applying it immediately and earn a few bucks to pay for school. Much better than working at Starbucks...

  15. I have an emergency fund which is in a savings account so I can access it right away, and I also have another larger account with one of Vanguard’s bond index funds. The bond fund value fluctuates a little, and if I do have to pull money out for an emergency, I am ahead of the game because 6% it much better than 1%.