The Dilemma of Emergency Funds - and how to solve it

I don’t think anyone can deny that emergency funds are beneficial. If an unexpected expense occurs or heaven-forbid you lose your job, having money available to use is extremely valuable. But for many folks, especially those who are younger, building an emergency fund, one with 3 to 6 months of expenses, can take many months or even a full year to obtain. The time it takes to save up for an emergency fund has a hidden cost.

Money you set aside in a savings account (to build an emergency fund) is losing value day-by-day in a savings account (due to inflation) and it also isn’t growing (because it isn’t being invested). The opportunity cost or hidden cost of building an emergency fund is the difference between the value of the money you have in the emergency fund and the value of what you could have had if you had invested that money in the market instead. Stated differently, stacking money in an emergency fund means there is less money you can use to invest in the market. Although there is no guarantee that money you invest in the market will increase in value, on average, the market tends to go up over time and money invested in index mutual funds (groups of stocks) tends to increase in value over the course of each year. My point? Maybe you would have been better off investing your money instead of stacking it in a savings account to build an emergency fund...

As if this wasn’t enough, it seems the timing of building an emergency fund is off. When we are younger in our careers with lower income and a big need for an emergency fund, it’s harder to save up for one and the opportunity cost of saving this money, instead of investing it, is quite high. However, when we are older in our careers with a higher income, it is much easier to save money for an emergency fund, but the emergency fund is not as crucial (because we are more financially stable and more likely to be able to cover the cost of an unexpected expense with money from our paycheck or money we already have invested in the market). What does this mean? Emergency funds are most useful at the time in our lives they are the hardest to get and less useful when we are better able to afford them.

So what is one to do?

When we need an emergency fund the most, it’s hardest to get. When we need it least, it’s easier to have. It is because of this dilemma that many folks have begun to question the traditional cash emergency fund. Perhaps opening a HELOC (home equity line of credit) from your mortgage makes more sense. Other people state if you can get a zero-interest credit card then what’s the problem?.Or, maybe it just makes sense to invest that money?

When it comes to pure math, many of these ideas make sense. The problem is that when it comes to personal finance a lot of it hinges on our individual behavior not our ability to do math.

Zero interest credit cards give us the ability to quickly purchase things we desire. Although it can be good for emergencies, many people end up using these cards even when they don’t have emergencies. They spend a lot more money than they would have if the money were being taken directly from their checking account or emergency fund. My point? Credit cards make it too easy to spend money we don’t have on things we don’t need. Most of us need less temptation, not more.

Opening a HELOC from your mortgage can be a great option but since many young professionals are just starting out in their careers, they may not even have a mortgage yet. If they do have one, they may not have much equity available to use. Plus, I personally don’t like the idea of putting my house at risk for an unexpected expense I could have planned for in advance (via a cash emergency fund).

Investing the money in taxable accounts via apps like Robinhood gives you the chance to allow your money to grow. However, if an emergency does arise, you’d have to sell your stock in order to use the money and selling the stock creates a taxable event which decreases your profit. Plus, it may take a few days to sell your stock and have the cash deposited in your account.

A Roth IRA seems to give you the best of both worlds. It allows you to invest money and take out your contributions at any time (while leaving your profits in the account) but it isn’t perfect. There is still a chance the market could experience a downturn and if that happens during the time you need your money for an emergency, then there is a chance that you may not have the amount of money you need when an emergency arises. My point? If you invest the money you take a risk that the money could go down in value and having less money available when you need it most is not ideal.

So how do you handle the dilemma of emergency funds?

Should you prioritize saving money in cash or just invest money in the market? The right answer for you depends on a lot of factors like your household income, job stability, monthly expenses, and net worth. If you’re wondering what I, as a senior family medicine resident, heading to fellowship next year, do…I do both.

I keep about $1000 to $2,000 in a savings account, save about $200 a month for large expenses like a vacation or Christmas gifts, then have the rest of my emergency fund money invested in index mutual funds in the market. Most of the money is in a Roth IRA but I do have some money in a taxable account (that I got as stock options from a previous company as a part of their compensation package). I also invest a portion of my income in my work retirement account. I’m pretty risk averse, so once I become an attending physician (and experience an income boost), I do plan to have 3 to 6 months of expenses in cash. My point? The right answer on what to do with an emergency fund may differ for each person, but having a little extra in cash, especially as a resident or person making the median income, is helpful. Just don’t forget to invest a little along the way.

Tell me, what do you think? What are your feelings about emergency funds? Do you have one? How much have you saved? Where is the money located? Have you decided to invest as you save (via a Roth IRA)?

3 Ways I Increase my net worth each month

Our net worth is an important financial number. It’s the value of our assets (things that increase in value) subtracted from our liabilities (expenses and debts we owe). The higher our net worth, the more financial security we have. Increasing our financial security gives us more freedom to do the things we love and live the life we desire. It means we can retire from our jobs early or work fewer hours if we want. We can spend each day doing what we love and can easily sell our assets to generate more revenue and money if needed. Because I want this level of freedom in my life, increasing my net worth is a continuous goal. Here are the 3 ways I’m doing that:

1. Investing money in my retirement account. As a physician who is employed by a large academic institution, I have the option to invest in employer-sponsored retirement accounts. Since I work for a non-profit hospital, I have access to a 403b which is quite similar to a 401K. Through this type of retirement account, I can invest money for the future which increases my net worth. Each month I put 10% of my income into my work 403b and invest the money in this account in index mutual funds, which are low cost funds that purchase a variety of stocks and bonds. Money in these index funds earn an average return of 8% per year. This means that each year I invest money, I earn about an 8% profit on my investment and that interest compounds each year as I continue to contribute money in the account. With an average interest rate of 8% per year, my money increases in value annually and doubles every 9 years. Putting pre-tax money from my salary into retirement accounts that are invested in low cost index mutual funds is one of the best ways I increase my net worth each year. The fact that these investment contributions also save me money in taxes each year is a bonus.

2. Paying down debt, early. Most adults have some form of debt, whether it’s a credit card balance, car loan, or home mortgage. This debt is a liability that subtracts from our net worth. Although many of us are fiscally responsible and pay a portion of the debt down each month, one of the things that has increased my net worth even more over recent years is paying the debt down sooner than required. In other words, instead of making the minimum payment, I pay more than what is required each month. Simply paying the minimum will cause me to pay extra fees in the form of interest and takes away money I could be using to invest or spend on other things. Paying more than the minimum each month, and eventually paying off the debt early, decreases my liabilities. As I mentioned earlier, decreasing liabilities increases my net worth.

3. Saving money in a separate account. One of the major ways I increase my net worth is by saving money. Although it’s sounds simple, it’s easier said than done. I’ve learned that unless I’m intentional about saving money, I’ll inevitably buy extra clothes or shoes I don’t need and find myself wondering why my bank account balance is near zero at the end of the month. One way I avoid overspending, is by saving money in a separate banking account. I have a certain “savings goal” each month and to ensure that I achieve that goal, I have a certain percentage of my paycheck that is automatically deposited into a separate account on the first of each month. Since this account isn’t connected to my debit card or credit card, it’s almost impossible for me to spend. Since I can’t spend it, I save it, and as a result, the value of my savings increases each month. As my savings increases, my net worth increases.

Although each person is different and may have various other financial priorities, we can all increase our net worth through at least one of these ways. Tell me, which method have you chosen to focus on to increase your net worth?

One of the best decisions I’ve made: automatic savings

When I graduated from medical school, one of the best things I did was set up automatic savings. I made a budget that had about 25% taken away in taxes, decided to live on 50% of my income, and made the bold move to have the remaining 25% placed in an entirely separate account. This account was reserved for building wealth through saving, investing, and paying off debt. It was one of the best things I did and here’s why:

1. It allowed me to grow my emergency fund. One of the best things about having part of my paycheck go into an entirely different bank account was being able to save money in a separate place. Because the money in this account isn’t connected to my checking account, I couldn’t spend it. Month after month, the money just kept adding up and before I knew it, I had saved thousands of dollars in an emergency fund. I remember looking at the account 6 months after I started saving and being so proud of myself. It made me even more motivated to keep saving. Plus, it gave me a sense of relief to know that I money to cover unexpected expenses.

2. I started investing early for retirement and building my net worth. Another awesome thing about automatic savings was that I was able to start putting money into my retirement account. Unlike money sitting in my savings account, the money I had automatically deducted from my check for retirement was being invested in a way that would make me even more money in the future. Although retirement may be decades away, I need to start saving and investing now in order to have enough money in those accounts to cover all of my needs. I don’t want to be relying on social security checks from the government trying to make ends meet on a small sum of money when I’m in my 60s. I instead, plan to invest the money now in a way that would allow me to live the life I want free from financial burdens.

3. I paid off a lot of debt. Regardless of whether you hate debt or don’t mind it, paying it off can feel like a weight lifted off your shoulders. Although I entered a loan forgiveness program for my student loans, I still had other credit card debt I needed to pay back. Unlike most people who go straight into medical school from undergrad, I lived in Washington, D.C for two years before starting medical school. Although that time was rewarding, I racked up lots of credit card debt. (The city was super expensive, and I used credit cards to cover some of my bills since my salary was low) By the time I left the city, I had thousands of dollars of debt to repay. When I got my first job as a doctor, I had hundreds of dollars automatically withdrawn from my separate account each month to pay off this debt. By the end of my first year as a doctor, I was credit card debt free! Now, instead of spending hundreds of dollars on a credit card payment each month, I’m able to invest even more money towards retirement and raise my net worth.

4. I now have money for vacations, Christmas gifts, and other indulgences. Along with investing for retirement, building my emergency fund, and paying off debt, having a portion of my check automatically sent to a separate account also allowed me to save money for things that bring me joy. I now have some money in a “vacation fund” so I can take trips and create memories with friends without racking up debt. I have also been able to save money each month for Christmas gifts so that my spending in December doesn’t put me in a financial hole for the next year. Plus, I have money saved for expensive purchases like a new phone or laptop should I need it.

5. I learned how to live below my means. I think this is by far the most important lesson I learned. As a physician, my life is a little different from most. I spent many years in school living off of student loans, and now must spend a few more years in residency where I’m paid a low salary by the government. However, once I finish residency, my salary quadruples. It’s an interesting timeline. Since there’s so much hard work and delayed gratification involved to get to the end goal, it can be very tempting to “not worry about money” and simply get what I want because I know that eventually I’ll be able to afford it. Although this seems fine, many people with this thought process inflate their lifestyles by too much, rack up lots of debt, and are unable to retire when they’d want to because they didn’t save enough money earlier on in their lives. I don’t want that to be me. Learning to live below my means has taught me to be less materialistic, more giving, and more appreciative for the things I have. It has also helped me learn to be humble and not to compare myself to other people. In other words, living below my means helped make me more mature.

My point? As you can see, automatic savings in a separate account has had many benefits on my life. Although it can be difficult to live on half of my paycheck while others seem to be living a much more lavish lifestyle, I realize that the sacrifices I make now will pay off in the end. Practicing self-discipline by saving money, is one of the best decisions I’ve ever made.