Cash Flow Decisions

Emergency Fund

This summer I got to enjoy one of the most anxiety ridden experiences any homeowner can go through: I purchased a new roof. Earlier this year I had started to notice some water damage on the ceilings upstairs and a few months after that a serious tropical storm added to my watery woes. It started to become obvious that my roof needed some attention. How much attention was debatable at that time. After haggling with my insurance company and receiving what I thought was a fair payout, I contacted a contractor to replace the roof. Ironically, the quote he gave me was right in line with the settlement from my insurer.

After the crew stripped the shingles, it was apparent that the roof was in worse shape than we feared. New plywood would need to be attached before the new shingles were to be added. This increased the cost of the project by about $4,000. In the grand scheme of things this was not a big deal. The additional cost was all I had to pay for out of pocket and for a brand-new roof with fresh wood, $4,000 ain’t bad. So, I happily wrote the second check.

But now I am left with a depleted emergency fund (and this was a very good example of an emergency). How do I replenish it? As I see it, I have three options: First, I could make a withdrawal from my non-retirement brokerage account and sell some short-term investments. Second, I could forgo my monthly deposits into said brokerage account for a while. Third, I could reduce my household spending.

Because my short-term investments are so liquid and stable, it can be tempting to sell these. This would be the quickest way to get my emergency fund back on track. But a more disciplined approach would be to go with strategy two or three – or perhaps a mix of both, which is what I decided to do. My emergency fund, while not exactly where I would like it to be, is enough to let me sleep at night. And I can always sell those short-term investments in a real bind. That is one of the advantages of having a “blended emergency fund”. Think of it like having two emergency funds. The first is not invested in anything; it is essentially earning no interest at all. The second is slightly more aggressive, holding a very conservative bond fund for example, let’s call it “cash plus one”.

How much money should be held in this manner will be determined by your current situation. Three to six months of your expenses is a good target. I like keeping the first 3 months in cash and the next 3 months in cash plus one.