Emergency Fund (Funding Question)

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stemikger
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Emergency Fund (Funding Question)

Post by stemikger » Sun Oct 03, 2010 8:44 am

Hey Folks,

Would you cut back on the amount you put in your 401K to complete a fully funded emergency fund.

By the end of 2010 I should have about $10K in mine. I would ideally like $25K. I figure if I bring my 401K down to 10% until the end of 2011 I can rebuild it. Of course I will go back to putting in the max in my 401K once it is built up.

Is this the right thing to do or should I just leave it at 10K for the next 5 years. The reason I say 5 years is because I only have 5 years left on my mortgage and after I completely pay off my mortgage I can buld up the emergency fund without cutting back on the 401K.

As always thanks for your input.

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Post by livesoft » Sun Oct 03, 2010 8:55 am

I feel a warm feeling coming over me ... I feel as if I am going back in time ... I feel younger ....

The answer: It depends.

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stemikger
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Post by stemikger » Sun Oct 03, 2010 8:59 am

feel a warm feeling coming over me ... I feel as if I am going back in time ... I feel younger ....

The answer: It depends.
LOL. I don't get it, but thanks anyway.

P.S. I posted a seperate thread thanking all the people who have helped me here and without mentioning names, you were one of the top 5 that I had in mind. Thanks for all your help. : )

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Post by livesoft » Sun Oct 03, 2010 9:04 am

If $10K covers 6 months of expenses (real expenses, not paying mortgage off early expenses), then I would be OK with putting money into the 401(k) first.

If I had $10K in a Roth that I could also withdraw, I would be OK with putting money into the 401(k) first.

I would not avoid the 401(k) in order to pay my mortgage off early.

I assume you have absolutely no taxable accounts other than your $10K. Otherwise you would just use your taxable accounts for the emergency fund AND to max out your 401(k) contributions.

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Post by Bob's not my name » Sun Oct 03, 2010 9:30 am

livesoft wrote:I feel a warm feeling coming over me ... I feel as if I am going back in time ...
livesoft wrote:I would build up Roth IRAs if I had no emergency fund and no means to contribute to both a 401(k) and emergency fund and Roth IRAs. That is, Roth IRAs would come first.

First, your emergency fund will be counted in the financial aid formulas, while your Roth IRAs will not be. Second, you can withdraw contributions from Roth IRAs without penalty. Third, if you don't have an emergency, at least you got your money in a tax-advantaged retirement account.

I think you have posted on this before, but I would pay the minimum to my mortgage while I was doing all this. I would not be paying my mortgage off ahead of time if I couldn't maximize retirement contributions and have an emergency fund.

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Post by stemikger » Sun Oct 03, 2010 10:20 am

Posted by Livesoft
If I had $10K in a Roth that I could also withdraw, I would be OK with putting money into the 401(k) first.

I would not avoid the 401(k) in order to pay my mortgage off early.
I defintely decided not to pay off the mortgage in lieu of the 401K, but I did look into the Roth like you advised me to do last time and unless I read it wrong there are too many restrictions to borrow against the Roth IRA, so I don't see how I could use that as an EF. Did I read it wrong, what am I missing on this.
I assume you have absolutely no taxable accounts other than your $10K. Otherwise you would just use your taxable accounts for the emergency fund AND to max out your 401(k) contributions.
Other than my 401K and my Vanguard IRA I have no taxable accounts. I don't have enough money to do both. So, the EF would be my only extra.

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Post by Bob's not my name » Sun Oct 03, 2010 10:33 am

stemikger wrote:there are too many restrictions to borrow against the Roth IRA
You can withdraw contributions tax- and penalty-free (which you should only do in an emergency). livesoft said this in your last thread and I quoted it above.

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Post by lmpmd » Sun Oct 03, 2010 10:34 am

I'm no expert, I just listen to experts. But I guess what I've thought was best is to create a decent emerg fund (4-6 mo living expenses) before funding retirement savings (401k etc). So my simplistic understanding was that it's best to fund the emergeny fund first (that it's the priority). Let's see what experts here say.

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Post by kenbrumy » Sun Oct 03, 2010 10:49 am

Not reading his other posts, I don't know how secure his job is. Of course, I don't think government workers or tenured professors/teacher are particularly safe anymore but they are more secure than the typical wage slave. If the OP has what he feels is a "very secure position" an emergency fund would only need to be enough to cover major car repairs or insurance deductibles. A "secure position" that, if lost, could probably be replaced quickly may be fine with a 6 month emergency fund. "Normal positions" should target a year. Most entrepreneurs should have two or more years in their emergency fund but they seldom do until the business is highly successful and sometime not even then.

As a point of reference, I once had a very secure position that I thought was beyond risk. I was laid off with very little notice along with 1,100 of my closest friends. I was lucky and actually found a job in less than 6 weeks but many people in my group didn't and went bankrupt, lost houses, got divorced, etc.... Ever since then I've always had two years of living expenses in ready cash available.

When I lost my job a couple of decades later I was out of work for 15 months. My lifestyle was so contained I didn't even spend all of the six months of severance pay I had gotten.

Bottom line IMHO, cut your 401k back to the match portion until you get your emergency fund fully funded. You have to decide what your level of risk tolerance is. You should also consider things beyond your control like disability (ST/LT insurance) and potential termination for any reason (sometimes you may really do something stupid - even tenured professors get sacked).

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Post by livesoft » Sun Oct 03, 2010 12:34 pm

You should be making Roth IRA contributions. Does anyone disagree with this?

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Post by DSInvestor » Sun Oct 03, 2010 12:49 pm

I agree livesoft's recommendation for Roth IRA contributions in this situation where the investor cannot afford to max out retirement plans and build up cash reserves. By making Roth IRA contributions, the investor takes advantage of contribution space. If the investor does not contribute, the contribution space is lost forever. If an emergency arises, the investor can withdraw up to the sum of all direct contributions without tax or penalty. In this case, he would be in a similar position as if he had not contributed to Roth at all. However, if there is no emergency he would have the advantage of more tax advantaged space.

If OP is concerned about short term volatility of the emergency fund inside the Roth IRA, he invest the Roth money in a conservative fund like a short term bond fund.

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Post by camper » Sun Oct 03, 2010 12:56 pm

DSInvestor wrote:I agree livesoft's recommendation for Roth IRA contributions in this situation where the investor cannot afford to max out retirement plans and build up cash reserves. By making Roth IRA contributions, the investor takes advantage of contribution space. If the investor does not contribute, the contribution space is lost forever. If an emergency arises, the investor can withdraw up to the sum of all direct contributions without tax or penalty. In this case, he would be in a similar position as if he had not contributed to Roth at all. However, if there is no emergency he would have the advantage of more tax advantaged space.
I agree. Well said.

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Post by stemikger » Sun Oct 03, 2010 2:10 pm

Posted by Livesoft
I agree livesoft's recommendation for Roth IRA contributions in this situation where the investor cannot afford to max out retirement plans and build up cash reserves. By making Roth IRA contributions, the investor takes advantage of contribution space. If the investor does not contribute, the contribution space is lost forever. If an emergency arises, the investor can withdraw up to the sum of all direct contributions without tax or penalty. In this case, he would be in a similar position as if he had not contributed to Roth at all. However, if there is no emergency he would have the advantage of more tax advantaged space.

If OP is concerned about short term volatility of the emergency fund inside the Roth IRA, he invest the Roth money in a conservative fund like a short term bond fund.
I apparently read the wrong information about Roth IRAs. If this is indeed the case, I think it will be a no brainer to put my EF in a Roth, so I get the best of both worlds. When Livesoft gave me this advice on my last post I did look into and apparently I received the wrong information. I will be calling Vanguard tomorrow to verify this and act accordingly.

Once again, you very smart folks have directed me to a place I would not have found on my own.

P.S. I am not too worried about the volatility because I hope I will never need it.

Thanks again,

Stephen Geraci[/u]

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Post by DSInvestor » Sun Oct 03, 2010 3:33 pm

stemikger wrote:P.S. I am not too worried about the volatility because I hope I will never need it.
Steve, You have a 10K reserve today and ideally you'd like 25K. You're concerned about having only 10K to the extent that you're asking if you should reduce 401k contributions to build up to 25K ASAP. This tells me that you're not comfortable with just 10K of cash reserve.

How would you feel if you had 20K in cash reserves one day and a week later the market tanks and you only have 10K? Emergencies can happen at any time and hoping that you won't need the money doesn't make the emergencies less likely to happen. If the Roth IRA is really going to hold part of your emergency cash reserve, consider the investment risk carefully.

I think that you need to consider and balance your financial objectives carefully. In the past, you were driven by your desire to be debt free and sacrificing retirement contributions and cash reserve to get debt free as fast as possible. This kind of strategy may make sense if you have high interest rate debt. Do you have any high interest debt? Balance is key. If you can find a way to simultaneously build cash reserves, build retirement assets and pay extra to mortgage debt, you'll be feel more at ease. You will feel that you're making progress on all fronts and not letting some other areas lag.
Last edited by DSInvestor on Wed Oct 06, 2010 1:53 am, edited 2 times in total.

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Post by LadyGeek » Sun Oct 03, 2010 3:33 pm

stemikger wrote:P.S. I am not too worried about the volatility because I hope I will never need it.
Adding to DSInvestor (we posted at the same time), give yourself some more time to think about that. You may never need it, or, you may need all of it.

There are some situations you can plan for in advance, some you can't. It's a matter of splitting your emergency fund accordingly.

Please see Emergency fund on the Bogleheads Wiki.

Take a look at setting up a multi-tiered emergency fund. Be sure to read the forum links for more insight (External Links at the bottom of the page).
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stemikger
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Post by stemikger » Mon Oct 04, 2010 6:20 am

Thanks you so much everyone. All the advice has been appreciated and now I have until December to decide what I am going to do.

If I had to decide right now, I think I will keep my contribution in my 401K at 10% for another year and starting at 2012 I am back up to maxing it out. In my 401K I get 5% put in whether I contribute to it or not. Also, I don't think doing this for one more year will make a huge difference in the end, especially since after this year, I will put in the max.

In the old days it wasn't a big deal for me because I always felt if I lost a job I would be able to get another one quickley. However many of my friends got laid off 2 years ago and I know some who are still out of work or way under employed. Some are working for a little more than minimum wage at 50 years old.

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