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8 Finish the Emergency Fund: Kick Murphy Out

When you reach this step, you have $1,000 cash and no debt except your home mortgage. You have pushed with such focused intensity that the ball is now rolling, and you have momentum on your side.

You are beginning to see the power of being in control of your largest wealth-building tool, your income. Now that you don’t have any payments, except the house, Baby Step Three should come quickly.

A fully funded emergency fund covers three to six months of expenses. What would it take for you to live three to six months if you lost your income? Financial Planners and Financial Counselors like myself have used this rule of thumb for years, and it has served my Total Money Makeover participants well. You start the emergency fund with $1,000, but a fully funded emergency fund will usually range from $5,000 to $25,000. The typical family that can make it on $3,000 per month might have a $10,000 emergency fund as a minimum. What would it feel like to have no payments but the house, and $10,000 in savings for when it rains?

Remember what we said about emergencies? It will rain; you need an umbrella.

I’m going to bang on this drum again because it is vital if your makeover is going to be permanent. The worst time to borrow is when times are bad. If there is a recession and you lose your job (read, “no income”), you don’t want to have a bunch of debt. In a recent Gallup poll, 56 percent of Americans said they would borrow on a credit card if a rainy day came, and it wouldn’t be difficult. I agree it wouldn’t be difficult because credit cards are issued to dogs and dead people every year, but that doesn’t mean it would be smart. A Country Financial Security Index survey found that 49 percent of Americans could cover less than one month’s expenses if they lost their income. Half of this culture has virtually no buffer between them and life. Here comes Murphy! Remember how we discussed that problems seem to be (and I believe actually are) less frequent when you have your fully funded emergency fund? Don’t forget that the emergency fund actually acts as Murphy repellent.

So, what is an emergency anyway? Emergencies include paying the deductible on medical, homeowner’s, or car insurance after an accident, a job loss or cutback, medical bills resulting from an accident or unforeseen medical problem, or a blown transmission or engine in a car that you need to function. All of these are emergencies. Something on sale that you “need” is not an emergency. “I want to start a business” is not an emergency. Prom dresses and college tuition are not emergencies. Beware not to rationalize the use of your emergency fund for something that you should save for and purchase. Sharon and I would never use the emergency fund without first discussing it and being in agreement. We also would never use the emergency fund without sleeping on the decision and praying about it. Our agreement, our prayer, and our cooling-off period all help us determine if this decision is a rationalization, a reaction, or a real emergency.

Keep your emergency fund in something that is liquid. Liquid is a money term that means easy to get to with no penalties. I use growth-stock mutual funds for long-term investing, but I would never put my emergency fund there. If my car engine blew, I would be tempted to borrow to fix it rather than cash in my mutual fund because the market is down (we always want to wait on it to go back up). That means I have the emergency fund in the wrong place.

For the same reason, don’t use Certificates of Deposit for your emergency fund because typically you will be charged a penalty for making an early withdrawal.

I suggest a Money Market account with no penalties and full checkwriting privileges for your emergency fund. We have a large emergency fund for our household in a mutual-fund company Money Market account. Keep in mind that the interest earned is not the main thing. The main thing is that the money is available to cover emergencies. Your wealth building is not going to happen in this account; that will come later, in other places. This emergency fund is to protect you against storms, give you peace of mind, and keep the next problem from becoming debt.

So, how much money should be in your emergency fund? We said it should be enough to cover three to six months of expenses, but should you go with three months or six months? If you earn straight commission or are self-employed, you should use the six-months rule. If you are single or you are a one-income married household, you should use the six-months rule because a job loss in your situation is a 100 percent cut in household income. If your job situation is unstable or there are chronic medical problems in the family, you, too, should lean toward the six-months rule.

If you have a “steady, secure” job where you have been with that company or government agency for fifteen years and everyone is healthy, you could lean toward the three-month rule. Customize your emergency fund to your situation and to how your spouse deals with the feeling of risk. This fund is for actual protection and for peace of mind, so the spouse who wants this fund to be higher wins.

In Baby Step Two, I instructed you to use all nonretirement savings and investments to pay down your debt. Clean everything out and become debt-free except for the house. Use all savings and investments that don’t have a penalty for withdrawal like retirement plans. If you used savings that you had in Baby Step Two (Start the Debt Snowball), you cleaned out even the emergency fund down to Baby Step One (Save $1,000). Now is the time to rebuild your emergency fund by replacing any money you may have used to pay debt. Many times I’ve met someone who, for example, had $6,000 in savings at the bank making 2 percent interest, and $11,000 in credit-card debt. The very thought of using $5,000 of that savings to pay the credit cards partially off is very hard. That $6,000 emergency fund is your security blanket, and fear rises up deep inside when someone like me mentions that you should use that money to Snowball your debt. You are right to feel that fear and to question whether you should spend the $5,000 to pay down the debt. You should use that money ONLY if you and your whole family are into a Total Money Makeover.

I know that even if everyone is onboard, gazelle-intense, and there is a plan, my suggestion still scares some of you. Good. Don’t you think one of the things that make the gazelle intense is fear?

As you budget over the years and your Total Money Makeover completely changes your money habits, you will use the emergency fund less and less. We haven’t touched our emergency fund in over ten years. When we first started, everything was an emergency. But as The Total Money Makeover begins to take effect, you have fewer things you can’t cover in your monthly budget.

What used to be a huge, life-altering event will become a mere inconvenience. When you are debt-free and aggressively investing to become wealthy, taking a few months off from investing will put a new engine in a car. When I say the emergency fund is Murphy-repellent, that is only partially correct. The reality is that Murphy doesn’t visit as much, but when he does we hardly notice his presence. When Sharon and I were broke, our heating-and-air system quit, and the repair cost $580. It was a huge, hairy deal. Recently I had a new $570 water heater installed because the old one started leaking, and I hardly noticed. I wonder if the stress relief that your Total Money Makeover provides will allow you to live longer?

I keep saying that you are debt-free except for the house at this point and saving to finish the emergency fund. What if you don’t have a home yet?

I love real estate, but do not buy a home until you finish this step. A home is a blessing, but if you move into home ownership with debt and no emergency fund, Murphy will set up residence in the spare bedroom.

Saving for a down payment or cash purchase of a home should occur after becoming debt-free in Step Two and after finishing the emergency fund in Step Three. That makes saving for a down payment Baby Step Three (b). You should save for the home if you have the itch before moving on to the next step. There are all sorts of folks who are eager to “work with you” so you can make it happen sooner, but the definition of “Creative Financing” is “Too Broke to Buy a House.”

Next Stop: Serious Wealth Building

Well, you have made it. Two or two and a half years from the time you start your Total Money Makeover, you can sit at the kitchen table with no payments, other than for the house, and with around $10,000 in a Money Market account. Close your eyes one more time and let your emotions and your spirit visit that place. Wow, I know I see you smiling now.

Once we have covered these basic steps and laid a foundation, the time has come to build some wealth. Remember, that is why we started a Total Money Makeover. We wanted not just to be out of debt, but to become wealthy enough to give, retire with dignity, leave an inheritance, and have some expensive fun. Stay tuned for some big fun.