Emergencies Versus Opportunities

Tim writes in:

We are working on our emergency fund. We put almost all of our extra income into the fund. The problem that I am wrestling with is that it is hard to watch opportunities go by while we work on this fund. It will take a year or two to fully fund our emergency fund (3 to 6 months). Example, I really wanted to buy some Ford stock when it was at $4 / share. I was pretty sure that over the next year it would do well, but it is a risk and at the time we were starting our fund. It has hit $12 per share in about a year. I know there will be other opportunities like this, but is hard to watch a missed opportunity.

Do you think the emergency fund should be fully funded before buying opportunities?

I’ve received several emails like Tim’s over the last year and they all point to the same thing. They all feel that putting their money into emergency funds equates to losing opportunities in other avenues of life. In Tim’s case, for example, the money he put into his emergency fund would have done much better for him had he put that money into Ford stock.

There are several points worth making here.

First, hindsight is 20/20. I can’t tell you the number of times I’ve lamented the fact that I didn’t buy any Google stock near the IPO. I told everyone I knew that it would be a big winner. I knew with every core of my being that it would be huge. And it was. I now look back with a sense of missed opportunity. Why didn’t I throw every dime I had into it?

Here’s the thing, though. It only feels like a missed opportunity because I now know what exactly happened to GOOG. Back in the day, I didn’t have such knowledge. I had no way of knowing whether or not Google would shortly be supplanted as the 800 pound gorilla of online search, just like they had replaced Yahoo! and Yahoo! had replaced Altavista, all within about a six year stretch.

Just because I now know it was a winner doesn’t mean that it wasn’t an enormous gamble at the time, one that, if I really step back and look at it honestly, I’m glad I didn’t take because the total risk wasn’t worth it.

Looking back at “what-ifs” as a justification to push your finances is always a bad idea, because it distorts the real picture of your investing skills. You remember the guesses you made correctly and tend to gloss over the ones you missed.

Second, emergency funds are about as unglamorous as can be. CNBC doesn’t breathlessly talk about how people are putting 5% of their paychecks into cash emergency funds. Instead, they’re glamorizing the stock picks of the week. Jim Cramer doesn’t throw chairs and yell about an automatic savings plan, after all.

CNBC (and most of the money press) promotes and sells and glamorizes a certain flavor of entertainment and lifestyle – the “big investor” lifestyle, as I like to call it. Why do you think there are tons of commercials for Escalades and the like on there? It’s because the “big investor” lifestyle is sold as being glamorous – and the marketing to people who are into that also goes heavy on the glamour.

Thus, when we think about investing, we don’t think of savings accounts as fun and exciting, but quite often that association is made with stock investing. A big part of that is the fact that there’s a lot of money to be made from people investing in stocks in the form of fees and commissions, while the same isn’t as true of savings accounts. The marketing dollars go toward glamorizing stock investing.

Third, the financial benefits of an emergency fund aren’t as easy to see as the benefits of other investments. All you have to do is glance at a stock ticker to see the benefits of a stock investment and, during a bull market like this one, the proof seems to come up all the time. “Look at all the money people are making,” people tell themselves, and that’s why people often invest near the top of a bull market.

On the other hand, the real benefit of an emergency fund is unseen in our day to day lives. We can’t see the unexpected. Our emergency fund doesn’t help us at all on a normal day, but a glance at that stock ticker tells us that we might have made a bit of money if only we had invested in stocks.

It’s on the abnormal days when our emergency fund helps us. It saves us from going into debt to cover a car repair – a debt that will come with a hefty interest rate. It saves us from racking up big credit card bills. It protects us from a job loss.

But our minds work in an interesting way. Once we make our way through those unfortunate events, we tend to forget about them and gloss over them, putting them into the past and not thinking about them any more. Most of the time, we move on from those rough events. It’s how we’re able to deal with our day to day lives. (I covered this idea in detail before.)

As a result, we think our lives are more even than they really are. We gloss over those big bumps in the road and see our path as being much smoother than it actually was. Thus, we don’t see the real need for an emergency fund anywhere near as clearly as we ought to, and compared to other opportunities that run up and slap us on the face, it can be hard to keep focus on the emergency fund.

Emergency funds often come off feeling like something we’re supposed to do, but it doesn’t feel like we’re really getting ahead when we do it. Opportunities, on the other hand, are something that we often passionately want to jump on board with because of the marketing and prevalence of information.

My suggestion for Tim is simple. Set up an automatic savings plan that contributes a reasonable amount to your emergency fund each week, something you’ll estimate yourself depending on your income and your budget. Once that’s in place, forget about it. Let it grow quietly like a mushroom in the cellar and don’t even think about it until a legitimate emergency comes along.

If you want to take advantage of opportunities that come along, use the remainder of your income for those – and go for it.

Eventually, you may find that you have a large surplus in your emergency fund due to years of (luckily) steady life. If you find yourself there, don’t hesitate to take some of that money and use it for another investment opportunity.

Aside from that, though, just set up the automatic savings, sit back, and don’t think about it. Don’t even consider the money you’re putting away to be on the table for any other spending. Pay yourself first.

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  1. Shannon says:

    If he feels bad about missing out on Ford when it was at $4/share, he can invest in Citigroup right now when it is at $3/share. Little doubt it’s going to hit double digits by 2011…

  2. lurker carl says:

    Gambling your emergency fund money on stock opportunities defeats the purpose of an emergency fund. Cash is considerably easier to use than a stock certificate when the furnace needs a mid-winter overhaul.

  3. Trent Hamm Trent says:

    Carl: spot on, succinct, and sweet.

  4. Toni House says:

    Your answer is right on in my opinion. Paying yourself first is and has always been and will continue to be the smartest step to take to secure your future. That does not say that you should not pay your debt off. Pay your debt off and stay out of debt. Being in debt is like slavery, you are working for someone else. Invest your money. Just remember there are always risk. Just make sure you find someone that can help you make the right decisions. God wants us to be prosperous he does not just want us to survive. check out my site http://www.firsttaxsolution.com and look for my book spring of 2010 Save Your Money Save Your Family http://www.saveyourmoneysaveyourfamily.blogspot.com

  5. JN says:

    From what I have read/heard, 3-6 months of an emergency fund is not really enough in this economy. Some folks who have lost their jobs have been out of work for over a year. I have been seeing that folks should have at least 8 months, if not more.

    It’s hard to pass up what seem like good opportunities, but I’d hate to see this person with no emergency fund if a big unexpected expense came up or he/she lost his/her job.

  6. Josh says:

    Also, people tend to have extremely selective memories when thinking about past performance and how good they are at picking individual stocks. Sure, Tim would have hit a homerun here but it just would have been lucky market timing, nothing else. Go back another year and he would have been extremely happy with putting that money in an emergency fund instead of watching the market collapse.

  7. Trent,
    You give the advice that is conservative and that is appropriate.
    It all depends on how much risk one is willing to take.
    Many wealthy people got that way via one or two huge leaps that they took (not bets, but well researched risks).
    It all comes back to risk tolerance. If you are comfortable with the worst case scenario – then go for it if you believe in the upside.

  8. Steven says:

    Just like true friends, emergency funds are something you don’t see the value of, until you need them.

  9. KC says:

    Carl’s comment is perfect. Also I wonder if you’d sell at $12 and use that to boost the emergency fund or would you let it ride? Where will it ride to? Ford is having a similar accelerator sticking problem on its China models that Toyota is. Ford also has a history of being a bunch of bone-heads. But my point is that you can only buy speculative stocks if you have a plan to get out – most people don’t realize that. If you feel you must speculate on stocks (and its fun, I do it too) don’t use more than 10% of your investing portfolio.

  10. psychsarah says:

    I agree with Trent’s comments about how our brains work. This post reminds me of the argument about the benefits of preventative healthcare. It’s tough to prove that it works, because you’re proving that something didn’t happen. If you have an emergency fund, nothing really painful happens when you hit a bump in the road, so you don’t really recognize the benefits of having it at the ready.

  11. Pop says:

    Recently, I’ve been wondering, though, if a 3 to 6-month emergency fund is too big. What if you have other safety nets to catch you other than your own funds? Why not pool your emergency funds with other family members…so maybe an extended family of 4 separate families collectively has a year’s worth of living expenses put together instead of TWO years sitting in a low-yield account had they all pretended that they weren’t going to help each other out anyway if someone lost a job. And what are the chances that everyone loses a job at the same time?

    Anyway, I wrote about this a bit here: http://www.popeconomics.com/2010/01/22/sumo-sized-emergency-funds-are-they-necessary/

  12. Sheila says:

    Well, I do regret that my Dad thought Microsoft was too risky when he was offered the IPO in the mid80s, but then it wasn’t my money he would have been risking. I dislike seeing my emergency fund earning such a low rate of interest in a “high yield online savings account,” but I’m not moving a penny of it.

  13. nicole says:

    Good advice. After the emergency fund is funded, the family is insured, the bills are paid, and retirement is saved for, then you can do whatever you want with the money left over. Get the basic safety stuff down before gambling. If you’re pro-active now about getting those basic needs down, there will be plenty of opportunities to invest in in the future.

  14. Lori says:

    We took one-half of our 6 month emergency fund and bought stock in the company I work for (large bank)and I was familiar with the track record of the stock. We were able to turn our 6 month emergency fund into a 12 month emergency fund in less that 6 months. we knew it was a risk but we are very happy that we took that risk.

  15. Debbie M says:

    I think it’s reasonable to have an opportunity fund as well as an emergency fund. I have used money from this fund to buy a year of retirement just before that option was canceled, to visit my sister when her husband was stationed in Belgium, and to visit a friend when she got a postdoc in Switzerland.

    Probably most “extra” money should go into the emergency fund at first, but as that gets more and more stable you can add more money to the opportunity fund. Of course, any money in the opportunity is also available for emergencies.

  16. While an emergency fund is very important, I think the key here is that Tim is putting in “almost all our extra income into the fund”. That can and does lead you to end up feeling like you’re being deprived. Also, you’ve made the assumption that all ‘oppurtunities’ are risky investment ventures. They’re not, they can just as easily be an unexpected change to visit an old friend or see a band, whatever. (And discounting all missed investments as only looking good with hindsight is very conservative view.)

    I second the suggestion that Tim also create an ‘oppurtunity fund’. Maybe only fund it with $50 or $100 per month depending on what you feel comfortable diverting away from the emergency fund, but enough that it is there if you decide you need it.

    And if it turns out you don’t need it and it gets really big, then you can sweep it into your emergency fund at a later date.

  17. Des says:

    If it’s ok to have an entertainment budget while you are still building an e-fund, why wouldn’t it be ok to have an “opportunity” or rather “gamble” budget? As long as you’re only risking what you can afford to lose, it can be a huge benefit. Not only does it provide an opportunity to grow your existing funds, but you begin to learn how to invest. I am firmly in the camp that says it is smarter to take $100 and spend it learning how to trade stocks than it is to wait until you have $10,000 before you jump in the water.

    People get into trouble when they risk everything they have on a single venture that doesn’t pan out. Failing will always suck. Just make sure it doesn’t break you.

  18. chacha1 says:

    Good question, good answer, and good comments! The opportunity fund is a terrific idea and could go a long way toward helping people not feel deprived by saving. Because it’s still SAVING, but it’s saving deliberately for a chance or a risk or just for fun, not only for “if the roof falls in/car dies/company folds.”

    The emergency fund is, to me and maybe to a lot of us, saving in case of something BAD that happens. The opportunity fund could be saving in case of something GOOD.

    As noted, everyone’s idea of a great opportunity is different – for me it might be cheap tickets to Auckland, for J.D. Roth it was a used Mini Cooper, for someone else it might be a barn for sale down the road.

    Missing out on a rare opportunity can really cause that late-night heartburn of regret. Even if you only see in hindsight that it was a *winning* opportunity, like Ford at $4. (And also as noted, a great run-up on a stock is only a winner if you sell the stock at the top.)

  19. NMPatricia says:

    I would like to echo PsychSara. Doing the “right” thing is usually not popular nor glamorous as Trent expressed it. People will say Wow if you make a stock killing but will be curiously silent when you have the money to pay for a huge emergency room visit. I know that right now, I get frustrated by the limitations we have because we are living a responsible life. But I also know that if something should happen, we could handle it. But it isn’t glamorous and not exciting.

  20. jim says:

    What if his speculative stock gamble had been to buy GM? Trent is right, hindsight is 20/20 and you shouldn’t be gambling with money that ought to be in an emergency fund.

  21. Ryan says:

    I think savings of any kind, especially for young people, is a hard habit to adopt. This factor is multiplied even more when you realize that an emergency fund might not get used for quite some time.

    Trent, I’m 100% with you on the Google IPO. Granted, I was only in the 7th grade, but I definitely wish I would/could have bought some shares.

  22. Anne KD says:

    I’ve started an emergency fund but named it ‘water heater’ with a number that my fast’n’dirty google search on replacement costs suggested. For the moment, I put in $50/month, which is all I can handle out of my ‘allowance’ for the moment. When I can, I’ll start another fund called ‘car repair or replacement’ and throw money at that. My husband doesn’t believe my savings plan is going to work- maybe he’ll believe it when the water heater breaks down and we can replace it using cash instead of taking on more debt on the credit card.

  23. Russ says:

    I thought Vonage would be a good investment. I had used them for years. I considered investing $10k (emergency money). IPO started around $17 and unfortunatley it drop a lot shortly after. Now it’s $1.43. As much as I thought it was the next best thing I was wrong! I did not invest in it. Why? Dumb luck! Intuition? No, I believe in investing in mutal funds not individual stocks. WHEW!!

  24. Moom says:

    You should think of it as emergency/opportunity/freedom fund. But you should start investing in riskier things until you have a reasonable cash base. Once you have enough cash in non-retirement accounts you can begin to make riskier investments too. I think the “emergency fund” title turns people off.

  25. I see this as really a matter of risk vs reward. What is the risk of putting money away in your emergency? The risk is that you *may* miss out on some good opportunities. What is the risk of *NOT* putting money into your emergency fund? Can’t make credit card payments? Can’t make mortgage payments?

    Trent put it perfectly in the last line…Pay yourself first.

  26. When I first began to fund my emergency fund I was under the mistaken impression that it had to be in a cash account that just sat there, waiting to be used.

    There is nothing that says that this emergency fund can be used to generate money for you.

    Maybe not in risky Wall St. investments, but why not at least put it in a high-interest checking account earning 4% or something like that.

    At least get it to do something for you.

  27. sjw says:

    “But our minds work in an interesting way. Once we make our way through those unfortunate events, we tend to forget about them and gloss over them, putting them into the past and not thinking about them any more. Most of the time, we move on from those rough events. It’s how we’re able to deal with our day to day lives. (I covered this idea in detail before.)”

    This is particularly true when one has an emergency fund. Because it makes that time you found out that the chimney is missing 1/3 of its bricks an annoyance, not a catastrophe.

  28. Curtis says:

    Note that GOOG is only a “winner” if you sell now. It could still be replaced, a la altavista, any time, sending the stock price right into the dumper. You have to be right twice in order to make money buying individual stocks low and selling them high. If Tim had bought F at $4, would he now be selling at $12? I doubt it, he’d be saying, “How much higher will it go?” Next thing he knows it could be back to $4. Better to build up the emergency fund and thereby have the security to take big risks like buying individual stocks.

  29. Elizabeth says:

    For me, the emergency fund is an investment- in my mental sanity. Knowing that I have one makes me less afraid to take risks in other parts of my life because I have a cushion to fall back if things don’t work out. Investing in stocks might be fun, but it will never give me peace of mind.

  30. getagrip says:

    In general I like idea of an opportunity fund as part of your spending plan.

    That said, the emergency fund isn’t an investment, it’s insurance.
    It’s insurance so you can risk other money on speculative opportunities.
    It’s insurance so you can step up and take that risk at work that may get you a promotion or end up costing you your job.
    It’s insurance that you can quit your day job and take a shot at making it in your own business. It’s insurance so you can drive that beater one more year while saving other money in the car account for a newer vehicle.

    Woulda coulda shoulda are all BS dreams. Did you honestly learn from it so you know what to look for today to base a real decision on or are you crying over get rich quick dreams?

    Make your plan, work your plan, tweak your plan as needed. Otherwise you don’t have a plan, you have a one paddle canoe spinning in the middle of the lake heading everywhere and going nowhere.

  31. Lily says:

    I used to feel guilty about not having a retirement fund. My finances were a mess and I just knew that disaster was at the door. Seemed like all of my friends were so much more “together” financially than I. And then last year, I heard about all the $ people lost in their retirement funds. I didn’t have one. So I lost nothing.

    Sometimes I lament with my husband about how we’ve squandered all of our money, spending wrecklessly. And he said, “Yes, but we’ve had a lot of fun.”

    We need to balance security with living. Having no security is like walking on a tightrope six stories high. Yet all the security in the world won’t keep away the biggest insult to our ego: death.

    What I got from Trent’s article is: find your own balance.

  32. Nicole says:

    Lily– that retirement money came back… maybe not from the peak or the gains, but definitely from what people put in, assuming they were saving for retirement regularly and were diversified. They lost paper money only at this point. Their principle is back in the black. That’s the way it works with long term savings.

  33. These comments are all awesome and a great study about how we all deal with losses of various kinds. First of all the retirement money did not come back. I contribute maximally to my retirement account with a generous employer match. My 2009 balance is now the same as my 2007 balance, despite the regular contributions during the 2 year interim. That means that I am still at a principal deficit that is equal to the contributions for the past 2 years. Based on the numbers my portfolio is still down. Tim is really worried about opportunity costs while he saves his emergency fund. Emergency funds are vitally important so I believe he should automate his savings, but go a step further as others have suggested and determine how long he can wait until he has his emergency fund in place, automate the savings at that rate then set aside funds for opportunity.

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