How much should we have in our emergency fund?

Having an emergency fund is important. 

No rational person would ever say an emergency fund is unimportant. 

Rationally, we know that bad things happen sometimes and we might need to have more liquidity at hand for such situations.

Whatever our persuasion might be in our journey as an investor, we cannot deny that cashflow is important. 

There could be times when cashflow is negatively affected and slows to a trickle or it could even dry up. 

That is when an emergency fund is drawn upon.




If our cashflow is a like a stream of water, an emergency fund is like a water tank that will dispense life giving water in the event of a drought.

The question of how big an emergency fund is enough is more difficult to answer because there isn't any one size fits all amount, obviously. 

Then, is there any guideline which AK could offer? 

Well, I could talk to myself, I suppose. 

Remember, however, AK is just sharing what he has done in his life. 

He is not a trained financial adviser.

Whether an individual's emergency fund is sufficient depends very much on his lifestyle, the number of dependents he has and how old he is.

Lifestyle

We could have a simple lifestyle or a lavish lifestyle or somewhere in between. 

Of course, what is considered simple or lavish would differ from person to person. 

No matter what our definition, we will have certain expenses which are fixed or routine and some which are discretionary.




Fixed expenses are mortgages, Telco bills, loan repayments, insurance premiums etc.

Discretionary expenses are holidays, birthday parties, visits to restaurants etc.


Of course, there is some room for debate as to what is fixed and what is discretionary. 

However, I will say that fixed or routine expenses are those that cannot be eliminated as easily as discretionary expenses.




Number of dependents

For those of us who are still single, some of us might have to take care of elderly parents or young siblings. 

For those of us who are married, some might have children who still need to be cared for. 

Our dependents will have routine expenses (and discretionary expenses) too.




Age

As we grow older, it is harder to find employment if we should be retrenched. 

If we manage to find re-employment, we might have to take a pay cut. 

Well, I am just taking my own advice to be pragmatic and not be overly optimistic or pessimistic. 

So, I think a bigger emergency fund as we grow older, all else remaining equal, is sensible.

So, bearing the above points in mind, is there a formula we can use to arrive at an amount that we should have in our emergency fund? 

Forgive me that I do not know how to express this in a neat equation. 

I offer you neat paragraphs:

If we take all our monthly routine expenses (our own + our dependents') into account, we will know what is the minimum amount of money we must have each month in order to maintain our current lifestyle. 

If we are in our 20s, multiply this amount by 6 to determine the size of the emergency fund required. 

If we are in our 30s, multiply by 12x. 

If we are in our 40s or older, multiply by 24x.




Someone once denounced me for being fake when I said I maintained an emergency fund enough to cover 24 months' of routine expenses. 

He didn't believe that I still needed an emergency fund because my passive income stream was strong enough to replace my earned income. 

Do you feel the same way?




If we remember my earlier analogy that our cashflow is like a stream and that our emergency fund is like a water tank, we will understand why I think an emergency fund is a must even if we should have a passive income stream.

So, how much should you have in your emergency fund? 

I hope this blog post has given you an idea.




Related posts:
1. Why a meaningful emergency fund is important?
2. Emergency fund: How much is enough?

What are some questions to ask when tempted by a 12% yield?

A conversation with a reader on a type of investment that I am usually wary about:

Hi AK,

I am looking for financial freedom but having little investing knowledge. I have a little situation...

About few months ago, I chance upon a company call XXX that was into Aquaculture business in a investing seminar. I was hooked by their business model in the way the speaker was presented as it was easy and simple to understand. They farm mud crabs and fishes and sell to local market. Investors that throws in the money get back their profits, very simple.

 They offered me 8% of guaranteed returns on the every 8th month if I were to invest SGD $2500 with them. The investment will end on 24th month. Having no basic knowledge of investing, I agreed and invested my money with them.

8 months has past, I received a call from the company and the portfolio manager invited me to his office to collect the returns generated from the business in a form of cheque and to meet me to talk about  further expansion of their business.

I went over to meet the portfolio manager in their office, he pass me my cheque. This time he explained that their company wanted to raise capital for expansion on a greater aquaculture sector and further explain that it is a stand-alone bond. This time the minimum sum of amount to invest is SGD $25,000 in the bond with a fixed return of 12% that will be given per annum that will stretch out to 5 years. There is a early exit in the 2nd year, however if I placed my money til the 5 year I will have my ROI and a maturity bonus. Total ROI that I will be receiving will be $16,875 if i keep til the 5 year.

 He showed me that they have a strong team of Aquaculture Researchers and specialists in his power point slides and pictures of them.

I'm very uncertain about placing $25,000 to Aquaculture investment as it is a very risky investment.

I would like to know that do you think of this type of investment?

My reply:

Hi,

1. Why is the business not able to get a bank loan?
 
2. Why is the business not able to get the backing of bigger investors?
 
3. Surely, it is a lot more work and costlier to seek out many small investors.

I did some research into the company. They claim to be a global company and the only reason I can think of for doing what they do to raise funds for this business is because it is a high risk business. I wonder if they have a credit rating?

A coupon of 12% per annum might seem very attractive for a bond but this is what is offered by junk bonds issued by companies which fail to secure a strong credit rating.

In fact, many junk bonds offer much higher yields now. 12% could be insufficient to compensate lenders for the risks they are asked to undertake. Have they listed the risks associated with the business? What are the things that could go wrong?

Do insiders have a big personal stake in the business? Or is the business being run solely on borrowed funds? How are they able to guarantee the safety of your capital invested if the business should fail?

I don't know enough to invest in something like this with confidence. So, I would rather avoid.

Best wishes,
AK

I know I have asked many questions in my reply to the reader but that is really the first thing we have to do as investors: Ask questions which matter.

It is not just how much money could we make but also what are the chances of us losing money and how much could the losses be?

Related post:
Nobody cares about our money more than we do.