A Guide to Emergency Funds

Tyler Linsten Personal Finance

There is nothing more fundamental to a healthy financial life than a fully stocked emergency fund. And there are many guides to emergency funds, but this one is mine.


I made this flow chart for you, dear reader.

Do you really need an emergency fund?

Some people like to think they’re immune from needing an emergency fund, giving reasons like “I’m retired” or “I have too much debt” or “I’m ridiculously wealthy” or “I have a very stable job and no debt” or “I live in self-sustaining bunker.”

But let’s get down to the definition of what an emergency fund actually is:

An emergency fund is simply a stash of money you only touch in cases of, well, emergency. (More on the definition of “emergency” later)

This means all of the above excuses are rendered moot.

  • Retired people need a stable, liquid pool of money in case any number of things happen – like large healthcare expenses – and especially as a buffer from feeling emotional about short-term market swings.
  • People deep in debt need an emergency fund because it’s simply the first step in the process of emerging from a negative net worth to a positive net worth. (True, it’s the same as saying, somewhat obviously, that they need to be out of debt)
  • “Ridiculously wealthy” people need an emergency fund because it’s a vulnerability to have all assets tied up in investments or illiquid property.
  • People with stable jobs and no debt need an emergency fund because a stable job is only as good as the economy, industry, or government their occupation serves.
  • The bunker people are already proving my point because their whole shelter is an emergency fund full of, presumably, dry goods and ammunition.

An emergency fund primarily functions as an immunization from all of the possibilities that everyday life brings all of us at one time or another. This would be the “lovey blanket” factor, as I like to call it. An emergency fund is a comfort in the face of uncertainty.

Most importantly, you need to be able to survive today to be able to plan for tomorrow. An emergency fund is key to that survival.

So, we’ve settled it. Everyone needs an emergency fund.

How much money do you need to keep in an emergency fund?

There are many different rules of thumb, but I generally recommend keeping three to six months’ worth of expected annual spending as an emergency fund, which translates to 25% to 50% of what you expect to spend annually on an ongoing basis.

This means you’ll need to know how much you expect to spend. You can figure out this number by using my one-pager here, or create your own copy in a digital version here. And don’t turn it into a budget – just an honest assessment.

View the PDF.

Three to six months is a guideline, but given that the average length of unemployment is currently about five months, I definitely don’t recommend going less than three months because that puts a heck of a lot of pressure on someone to get a new job in the event of a disruption of employment or a very large unexpected expense.

Factors encouraging a larger emergency fund, all else equal:

  • High debt levels relative to income
  • Having dependents
  • Known health issues
  • Working in an economically-sensitive industry (businesses more likely to rise and fall in cycles)
  • Unpredictable patterns of income, and/or when self-employed or working for a smaller company
  • Having a low savings rate
  • Having a low risk tolerance
  • No disability insurance in place
  • High deductible health insurance
  • Inadequate home/auto insurance coverage
  • Concentrated investment positions (non-diversified portfolio)

Factors encouraging a smaller emergency fund, all else equal:

  • Low debt relative to income
  • No dependents, or having a two-income household
  • Good health
  • Working in a stable industry (think healthcare, education, government)
  • Salaried income or pension/annuity income
  • Having a high savings rate
  • Having a high risk tolerance
  • Sufficient disability/auto/home insurance
  • Low deductible health insurance
  • Diversified investment portfolio

Where should your emergency fund live?

Simple: A high-yield savings account, most likely in an online-only format to get the best rates. Here’s an example of the difference between the average rates offered by online and in-person branches over the last five years:

After a years-long marathon of interest-free deposit accounts, we’ve finally made it back to the world of getting a decent rate of return on savings products. It might not last long, but right now you can get a 2% annual yield with many reputable institutions.

Paying a decent interest rate is important because this will allow the account to at least have a chance at keeping up with inflation. Plus, free money is nice. A $50K emergency fund will produce $1,000 in interest per year right now. That’s not nothing.

Just make sure the account is FDIC-insured (or NCUSIF at a credit union). Also confirm your account doesn’t exceed deposit insurance limits (generally $250K) – but most people won’t have to worry about this for an emergency fund.

To compare accounts, Bankrate and NerdWallet have pretty good screeners.

What constitutes an emergency, anyway?

Suze says no.

This is the really subjective part. You could say I’m an emergency fund fundamentalist, because I don’t believe in using the account as a slush fund. There are only a few reasons you should ever take money from this account:

  • Job loss
  • Paying for a high medical insurance deductible or coinsurance
  • Any incidents/accidents that can’t be reasonably (or aren’t) covered by insurance*

That’s it.

No, not that other thing you just thought of. Only job loss, medical deductible/coinsurance, and only the craziest random things.

This is not a stash to be raided for vacation, (especially not) for buying a home, for home renovations, for buying a car, for fixing a car, for getting a new roof, for yada, yada, and/or yada.

Let’s talk about that “*” above. The phrase “can’t be reasonably covered by insurance” is an important one. Most of these instances will end up with the final verdict of “you should have allocated for that in your expected spending” via insurance premiums or deductibles. This means, for instance, that having to spend a chunk of money for auto insurance deductibles or auto maintenance should be planned for. Or your insurance policies should be structured so that a paying a deductible doesn’t necessitate emergency-like spending.

Why not a new roof? Simple: Replacing a roof shouldn’t sneak up on you. It’s an expense that should be planned and saved for over the span of years. Now, a random roof leak would be different. It certainly would be unexpected and should be considered an emergency because it’s unlikely that homeowner’s insurance will cover it if it’s normal wear and tear or negligence (it also needs to be urgently fixed).

A lot of this comes down to your expected annual spending. If a spending item falls into any of the categories listed on the sheet I provided, it probably will be denied from being bailed out by your emergency fund. Own a home? You better be putting a huge number down for “Home Renovation / Repair”. Same in the auto category: If you own a car and leave “Auto Repairs / Oil Changes / Other Service” blank, then you, my friend, have built a BS Budget.

Biggest of all, your “Other Spending” category sure as hell better not be blank. That’s where you allocate for all the random spending that would be impossible to predict – and it’s not unreasonable to have it equal 10% of your expected annual spending.

Your emergency fund has two best friends

Insurance is the key to stabilizing the firewall around your emergency fund, but it’s also aided by keeping a healthy “float” in your checking account.

First, insurance allows you to hedge against most of the low-probability / high-cost events you could face (death, disability, flood, fire, earthquake, theft, burglary, severe illness, car accidents, even lawsuits or professional liability – the list is long).

Second, a healthy float in your checking account will allow you to pay for some the random non-emergency items that arise. This lowers the tendency to run to the emergency fund for a quick buck. Simply take your expected annual spending and divide by 12. You should seek to have a month’s worth of spending remaining in your checking account at all times. For a household expecting to spend $90K per year, this buffer should be set to roughly $7,500. After all the normal bills are paid, this buffer will finance things like the random new bumper, new oven, or tickets to the Hawaii trip. If your checking balance goes below one month or above two months of spending, then it’s time to re-calibrate.

How do you build an emergency fund from scratch?

Yes, it’s daunting. If you don’t have the funds to just throw a huge chunk of change over to a high-yield savings account, you might see this as an impossible task.

Two steps will aid in fully funding your emergency fund:

  • 1) Treat it as an expense: Choose a date you think you can reasonably get the account fully funded. If that day is three years from now, then a monthly expense for your emergency fund is the equivalent of 1/36th of the fully funded value. (A $30K fund would need roughly $833 in monthly deposits to reach its goal in 36 months)
  • 2) Automate: This part will create a forced commitment to the step above. You’re more likely to keep to the goal of forced saving if it’s something you have to turn off to disrupt. Get the courage to set up an auto-deposit and commit to treating it as a fundamental necessity to your annual spending. Nothing will get you to truly consider other spending than automating this step.

We’ve covered why you need an emergency fund, how much to keep there, where it should live, when it’s OK to spend from it, and how to begin building one. Anything you think I missed? Questions about emergency funds? Let me know your thoughts.

GET or DreamAhead for College Savings? Choose Neither

Tyler Linsten Investing, Personal Finance

It’s (still) a mess, and Washington state taxpayers should be pissed.


These aren’t the plans you’re looking for. (Source: Disney)

I’m not going to give you a great breakdown on how to choose between Washington’s two plans, GET and DreamAhead. No, this post is a short dispatch on why you should consider other options.

Let’s take a quick, 30,000-foot view of the situation:

Washington really screwed up its first shot at its GET (Guaranteed Education Tuition) program, a system designed to let residents prepay for college credit as an alternate means of saving for college. To put it nicely, this made for a chaotic experience for those looking to plan for college in the state. Here’s an example of how bad things were:

Source: Spokesman Review

So, yeah, that wasn’t good.

Then the state tried to fix it by freezing GET for new investors for two years, revamping it, all while introducing in parallel a separate, more traditional 529 college savings plan in 2018, DreamAhead, which is a mainly-DIY tax-advantaged option that most states also offer. They opened a limited window of time for GET participants roll over credits into DreamAhead (and these investors now make up a majority of the accounts in the DreamAhead plan).

Now, informed Washington residents are forced to answer the following question when approaching college savings:

“Do I trust that GET is fixed, and if I don’t, should I opt to go with DreamAhead to save for college?”

Short answers: No, and no. But let me explain why.

The process I use for almost any investing decision goes something like this:

Instead of building a list of good things (“pros”) and spending a lot of time weighing whether or not they overcome the negative things (“cons”), I go right to the cons. Think of a K-9 unit, but a person with a laptop and a cup of coffee, tuned to find financial BS. Most important to this process is the belief that there is no pro good enough to outweigh a “dealbreaker,” which is just a really bad con. Simply put, there are too many reasonable investment options to ever settle for one with really bad attributes – so kick out the bad ones first.

It ends up being much easier to invest by being very picky, declaring early and often when certain attributes are dealbreakers and thus un-investable. (With investing, almost always, cost will be the dealbreaker)

Here’s where GET/DreamAhead come back in.

When approaching the question of how a Washingtonian might save for college today via GET or possibly DreamAhead, I’m looking for dealbreakers, as you might expect. My first hurdle for this process was determining whether the state learned its lesson or not, and if they’ve moved beyond the likelihood of screwing this up again.

It took me about three minutes to figure out that they have not turned the corner. Whatever poison was in the well, whomever is still on such-and-such committee, and however they make decisions – it’s clear they haven’t purged enough. The fly is still in the ointment. The DreamAhead apple did not fall far from the GET Tree. You get it. All you have to do is look at the portfolios offered within DreamAhead:

Really bad portfolio construction in action. See it here.

This snapshot is a small slice of a portfolio provided within DreamAhead, and is intended for students expected to start college in 2036. The numbers 24 and 23 indicate the percentage of the account that will be invested in each fund, as follows:

24% in Fidelity’s Total Market Index Fund (ticker: FSKAX).

23% in Schwab’s Total Stock Market Index Fund (ticker: SWTSX).

You don’t need to be a financial expert to see these funds are named similarly. And if you are a financial expert, you’d instantly conclude that these funds are effectively carbon copies of each other. They are virtually indistinguishable from each other. This is not normal to see in a reasonable portfolio managed by “professionals” being paid millions of dollars, let alone in a state plan that should be trying very hard to earn back the trust of investors.

Here’s a look at how both of these funds allocate to size and “style” traits, courtesy of Vanguard:

“OK, so their holdings look the same in this weird-looking chart, but what about performance?” you might ask. “Maybe this is where they differ.” Well, here you go:

The fidelity fund is in blue. The Schwab fund is in red.
Red + Blue = Purple.
They’re the same. The line is purple.

DreamAhead does it with bond funds, too. For all intents and purposes, these two funds in their conservative portfolio are also identical:

They split this up into two funds, because…?

A Metaphor Worse Than “Coke or Pepsi”

These weird portfolio choices are not like a restaurant offering both Coke (the Schwab fund) and Pepsi (the Fidelity fund) on the menu, where both Coke and Pepsi fans will be happy. This is also not like a restaurant offering one “cola” by just mixing both Pepsi and Coke, with the result of each party getting at least some of their favorite drink. No, it’s dumber than that.

The perfect metaphor for this portfolio choice is that of a person straddling the Washington/Oregon border with one foot in each state, repeatedly leaning left and then right to take in alternate breaths of air so as they will be diversifying the air they breathe. It’s the same damn air!

To be clear, what we’re looking at here should be considered a nitpick. But when it comes to your money, or your child’s money, or grandma and grandpa’s money, and, more specifically, the future of whomever is being invested for, can there really be a margin for error? On the heels of a major debacle that the state put investors through, can these programs afford to allow financial shenanigans back into its offerings? Can investors look past this weirdness in the portfolio and give DreamAhead the benefit of the doubt that they have reformed? I say, emphatically, no. The proper adult supervision has not made its way to the board room of this program.

Dealbreaker.

Sadly, It Gets Even Worse – Follow the Fees

Remember what I said above about cost? It’s another dealbreaker in DreamAhead, too.

There’s a bit of a messy hierarchy in place — Washington hired Sumday, a subsidiary of BNY Mellon, as its DreamAhead plan manager, but BNY scored another huge victory. BNY also managed to get another subsidiary, Lockwood Advisors, Inc., as the investment advisor on the plan. This means that BNY acts as both the plan manager and the investment advisor on the plan. So it’s fair to assume these entities are all one and the same.

The numbers part of this comes in when we consider how plan participants are charged for using DreamAhead. There are numerous components, but the most relevant being the $35 annual per account fee, of which $30 goes to BNY/Sumday/Lockwood.

Source.

Here is DreamAhead’s cost estimate for a $10,000 lump sum invested over various time periods in moderate year of enrollment portfolios:

Using our familiar 2036 portfolio, we see a total cost of $702.81 over ten years, which means roughly 7% of the original investment is eaten up by fees.

It’s also easy to see that roughly half of the $702.81 is eaten up by the account maintenance fee (10 years x $35 per year = $350).

Oregon Also Uses Sumday, but Investors Pay Less

Our friends to the South also use Sumday as their 529 plan manager:

Oregon and Washington both use Sumday for their 529 plans.

Despite using the same plan manager, Oregon’s investment options for the equity portion of its own 2036 year of enrollment portfolio are not ridiculously constructed with redundant options like Washington’s. They use a simple split between low-cost US and international Vanguard funds:

This is what non-bonehead investing looks like.

Oregon’s plan does not have the $35 annual maintenance fee:

Source.

Here’s how it looks in Washington:

Source.

You’ll notice nearly identical asset-based fees (0.30% vs 0.284%), but the real kicker is the added $35 fee in Washington state.

Here’s the same estimate of fees on a $10K investment for Oregon’s plan:

Cost to Oregon investors: Nearly half.

This is a very roundabout way of showing you that Washington state DreamAhead investors are paying nearly double the fees of Oregon 529 investors. Since both states use the same plan manager, Sumday, it’s hard not to conclude that Washington state investors are paying more simply to get a worse portfolio, as overseen by Lockwood, since they are the only major difference between the two plans.

The focus immediately falls on figuring out what BNY/Sumday/Lockwood is doing to earn the extra fee. Either way, I think it’s clear they have done one of the two following things:

— Offered DreamAhead a bonehead portfolio of investments, failing their fiduciary duty to plan participants.

or

— Failed to dissuade the state from implementing its own bonehead portfolio, which I’d say is still failing its fiduciary duty to plan participants (along with the failure of those in charge at the state).

Now, don’t get me wrong. BNY/Sumday/Lockwood knows the portfolio is boneheaded – they employ plenty of smart people. It’s plain to see if you know what you’re looking at. It should evoke various forms of “Why the hell would anyone build a portfolio like this?” from anyone who cares to look closely.

Now, at worst, the fact that this DreamAhead portfolio made it to the menu is akin to the existence of a hidden watermark on a photo or a line of code an engineer hides because they think no one will notice it. It would be an Easter Egg / middle finger and a reminder that there is still an epidemic of allowing a false portrayal of sophistication to those who don’t know any better.

Let me spell it out, if the worst case scenario is true:

More funds in the portfolio, even if they’re duplicates —> Imply complexity and sophistication —> Fee justification for BNY/Sumday/Lockwood.

(This would be the most damning accusation on my part, and I’m plenty willing to be convinced that BNY/Sumday/Lockwood tried their best to fix the portfolio)

But at very best, this is another absolute failure by the state of Washington to put adult supervision in the room. To hire the right people. To listen to the right voices.

But it doesn’t look very good for BNY/Sumday/Lockwood. Even Sumday’s CEO, Doug Magnolia, gave the then-proposed investing options his stamp of approval in November 2017, shunning the opportunity to declare concerns about the options on the table, according to meeting minutes that are publicly available:

Source.

In the latest update, Magnolia updates the state on how DreamAhead is doing:

May 15, 2019 meeting minutes.

I’ll do the math: $817 million multiplied by the portion of the asset-based fee that goes to BNY/Sumday/Lockwood (0.12%) is equal to $980,400. Then, we multiply the 29,421 accounts by the $30 portion of the $35 annual account maintenance fee that BNY/Sumday/Lockwood receives, which totals another $882,630. In total, BNY/Sumday/Lockwood is collecting at an annual rate of over $1.8 million in fees from investors, growing as new accounts and assets rise. Pretty nice haul.

A Bad Plan Gets Bad Results

Here’s another indicator of something you don’t want to see in a 529 plan:

Cash preservation (100% money market fund) is by far the most popular choice of DreamAhead investors, even though only about 30% of beneficiaries are teenagers. Source.

The whole purpose of a tax-advantaged investing account is pretty simple: Take advantage of the tax benefits given, so you can compound investing gains over a longer time horizon. You put money in, it grows tax-free, you take it out and spend on college tax-free. Even those looking to enroll soon, or are already enrolled, don’t necessarily need to be in 100% money market funds. Here’s why seeing this lopsided split is a problem:

  • Sitting in money market funds is not investing.
  • Having low, or no gains before funds are withdrawn for college expenses wipes away any/most tax benefit available, thus defeating the purpose of using a 529 plan. It simply becomes a transfer of wealth to the plan manager via fees.
  • BNY/Sumday/Lockwood is incentivized to not fix this issue because an uninformed investor is a profitable investor. Low volatility – as is the case with “investing” in “cash preservation” – leads to the reduced probability of losing accounts due to investors being risk intolerant. This stable allocation of safety also leads to a very steady and predictable income flow for BNY/Sumday/Lockwood.
  • With so many choices on the investing menu, along with confusing terms like “Income & Growth,” many investors are likely retreating to the implied safety of cash preservation. Here are how many choices a DreamAhead investor has to navigate before settling on an option:
    • Conservative Year of Enrollment Portfolio
    • Moderate Year of Enrollment Portfolio
    • Growth Year of Enrollment Portfolio
    • Cash Preservation Portfolio
    • Income Portfolio
    • Income & Growth Portfolio
    • Balanced Portfolio
    • Conservative Growth Portfolio
    • Moderate Growth Portfolio
    • Growth Portfolio

“Cash Preservation. Yeah, I like that sound of that. I’d certainly like to preserve my cash.” — Investors, who have too many options and not enough help from the advisors they’re paying.

Conclusion: Fool Me Once…

Shame on Olympia.

The conclusion is simple: Washingtonians, save for college elsewhere. Don’t do it in Washington, unless there is a radical change in leadership with GET/DreamAhead. The program can’t be trusted and has shown it hasn’t learned from its past mistakes. Residents can use any other state’s 529 plan without restriction because there are no in-state tax incentives for college savings to remain in-state as Washingtonians. One might start with Nevada’s plan, led by Vanguard. Or start with Morningstar’s list of best plans.

Should You Buy Uber? You Probably Won’t Have a Choice

Tyler Linsten Investing, Seattle Mariners Shaming

Uber shares for everyone!


Uber-large black banner.

Love them, or hate them, Uber is out of the gate and now trades publicly on the New York Stock Exchange. It was the ninth-largest IPO ever.

As with any hot new public offering of shares, many investors want to know if they should get a piece of the action. The verdict: If you own any kind of passive index fund, you’re going to own it. (And if you choose not to own index funds, then I wish you luck in your uphill battle)

The same goes for any other mega-IPO. These companies debut at huge valuations and will be added to indexes, like the S&P 500, within their first year of trading. Remember Facebook a few years ago?

We generally think of IPOs as being a young, unknown companies making their first splash on a grand stage, but that isn’t the trend as of late. We’re now seeing more mature, nationally-recognized firms emerging from private status much later in their life cycle. This means that right off the bat they will be eligible for the most widely-tracked indexes simply because of their size. If you own any kind of broad-based, or large capitalization index fund, you will soon enough have a small percentage of your portfolio in Uber.

But this dynamic – owning little bits of a ton of companies – is exactly the kind of strategy to take. It allows us to sidestep the “should I buy it??” questions, and instead focus on other things – like, literally anything else you can possibly think of. Want to spend (waste) some time watching the Seattle Mariners? Go right ahead, you’re free to do it because you don’t have to analyze Uber’s next quarterly report. You’re gonna own a little chunk of it. The alternative is an investing reality you don’t want to endure.

This is the beauty of being a passive investor. Take, for example, Danaher Corporation (ticker: DHR). I have never heard of this company in my life, and this is kind of my thing to know. But guess what – I own it! It’s actually the 66th largest component of the S&P 500. Thankfully, I didn’t have to decide whether its investment prospects were rosy or grim. I just own a tiny chunk of it and can live my life doing other things. Just now, I took a break to make a snack. In no part of this break did I have to dedicate time to check in on Danaher Corporation. 100% of my break time was devoted to my snack. What a time to be alive.

The hardest hurdle to overcome as an investor is the lure of the stock pick. The best way to win that game: Don’t even play.

See also: Citizen Kane’s Investing Mantra. (“Well, I’m sorry, but I’m not interested in gold mines, oil wells, shipping or real estate”)

Tax Refunds Are Down – That’s a Good Thing

Tyler Linsten Personal Finance, Taxes

Beware: AUTHOR HAS BEEN TRIGGERED


I am strangely enraged by people who defend this weird desire to have a big tax refund. They tend to say, “I like knowing there’s something coming my way in April.” This is largely anecdotal, but I hear it all the damn time.

Earth, to you Big Refund People: Your argument is terribly flawed and this is a supreme example of what’s wrong with personal finance in America.

Disclaimer: None of this massive rant applies to lower-income folks who may have tax complications due to the Earned Income Tax Credit or other various matters related to income uncertainty. They have it hard enough and don’t need me sending bad karma their way. No, this is for the six-figure earners I know. Yeah, you guys. 

I was compelled to make this post after seeing this CNN article, knowing that most people will see it in a negative light:

This is a good development

As reported by CNN, the average tax refund last year was $2700. But we also know that 41% of Americans cannot afford an unexpected $400 expense.

Translation: Refunds are huge, yet people are still broke.

People think they’re being responsible by setting themselves up for a large tax refund. In reality, this is a tax-free loan to the government and has basically no chance of being utilized in a smart way. Full stop. If this is your saving strategy, I am here to tell you it is not a good one. It is a band-aid intended to cover up the bullet wound that is your financial discipline.

If you skip lunch and then eat two dinners, you won’t be losing weight. People are convincing themselves that this is an effective financial diet.

Some may think that they’re performing some kind of a preventative financial measure because they know they aren’t good savers, and they would immediately spend the extra money every paycheck if they withheld a more appropriate (smaller) amount for taxes. HELLO? If you don’t think you can handle seeing a few extra dollars arrive with every paycheck, do you really think you’ll wisely allocate a one-time lump sum of thousands of dollars? I get the logic, I really do. But it’s wrong. People, stop doing this.

There’s also a big difference between making sure enough is withheld for taxes (and generating a small refund, which is fine) and the aforementioned tax refund-as-a-savings-account delusion. A small refund is OK – it’s a margin of safety against paying a penalty for underpayment. You never want to owe money at tax time. But setting yourself up for an obvious, huge refund is just silly. If you don’t have the discipline to save money weekly or bi-weekly, you certainly don’t have the discipline to save your mega refund.

Good personal finance rule: Receive interest, don’t pay it

With interest rates now being much closer to being “normal,” it’s easy to once again make the argument about passing up interest on the amount of these mega tax refunds.

It’s dead-simple to earn an FDIC-insured 2.20% APY in a savings account right now. Given that $2,700 refund, people are technically leaving about $60 on the table over the course of the year. It’s nothing major, and not even close to being the real argument here, but it’s not nothing. Call it a nice dinner out to celebrate making a wise tax decision. To me, that’s worth it.

In summary, Uncle Sam will always get the exact amount he’s owed. No matter what. There is no free lunch. Should people decide to convert this process into a twisted game of delayed gratification, then, well, that’s on them. But don’t say I didn’t try to change their mind.

Rant: Over.