An emergency fund is a pool of money set aside to cover unexpected expenses so you do not have to rely on debt when something goes wrong. Emergencies might include things like a major home repair, urgent travel for a family emergency, or another situation that requires quick access to cash. The key is that the expense is truly necessary and unexpected. Using the money for discretionary purchases defeats the purpose, since the fund is meant to be there when a real financial shock occurs.
Traditionally, an emergency fund is sized at about three to six months of normal household expenses. For example, if your household spends $5,000 per month, your emergency fund might range from $15,000 to $30,000. Physicians often think about this in relation to disability insurance, since many long term disability policies have waiting periods of around 90 days and do not begin paying benefits until several months after a disability occurs. Because of that gap, having four or more months of expenses saved can help cover living costs while waiting for insurance payments to begin.
An emergency fund should be a high priority early in your financial life, even during training. Even a small starter fund can prevent you from taking on high interest debt when unexpected costs arise. Ideally, you build the full fund within the first year or so after starting your career. The money should be kept somewhere safe and accessible, such as a high yield savings account or a money market fund. The goal is not to earn high returns but to protect the money and make sure it is available when you need it. In this case, protecting your principal matters far more than trying to maximize investment returns.
What is an emergency fund? An emergency fund is a pool of money that you can readily access to keep you from having to go into debt in the event that an emergency comes up. Now, the tricky part about an emergency fund is how do you define an emergency, right? What is an emergency really? And we can think of some examples that are pretty good emergencies. For example, let's say your air conditioner goes out right. And you're living in Houston and it's July. That's an emergency, right? I mean, it's literally life threatening to not have AC. Living in Houston in July. And so that's something that you might pay for using an emergency fund. Likewise, let's say you get a call that grandma's on her deathbed, right. And you need to buy some plane tickets. And you got to get there today. You know, that's not going to be a cheap plane ticket, and you're going to need some money to buy it. That kind of money can come from an emergency fund. Now, what's not an emergency? Well, let's say you heard about the latest Taylor Swift concert, and the tickets are kind of expensive, and you don't have the money to buy them unless you raid your emergency fund. Well, that probably doesn't qualify, does it? Right. So you got to be careful tapping an emergency fund if you're just using it as your slush fund. It may not be there when you have a real emergency.
Now, classically, an emergency fund is composed of an amount of cash equal to something like 3 to 6 months worth of your usual household expenses. So if you're spending $5,000 a month, an emergency fund would be something like 15 to $30,000 sitting in cash in an account that you can get to very easily. Now, how many months should you have? Well, one month is better than none, and obviously six months is better than four. But in a lot of ways, the way doctors think about this is they think about their long term disability policy. Now, a lot of doctors don't have a short term disability policy, and most of their long term disability policies have a 90 day waiting period on them. However, those policies don't start paying until a month later. They're paid in arrears after the month is over. And so it's really four months before you start getting payments from your long term disability insurance. So four months is a pretty reasonable period of time for doctors to make sure their emergency funds will last. But keep in mind, when something bad happens, there's often some additional expenses as well, whether they might be medical expenses or other things. So having a little bit more than that is not a bad thing. Now, an emergency fund ought to be a pretty big priority early on in your financial life.
Even a resident physician ought to have some sort of an emergency fund. It's obviously going to be smaller, because a typical resident is spending less than a typical attending physician. But you know, when you become a resident and you start making money, this should be a pretty big priority. Maybe even the number one priority when it comes to what to do with the money that you don't have to spend this month. Of course, there are a lot of other competing priorities when you're just starting out in life. Maybe you have a credit card that's charging 29% interest. Obviously, that's also a huge priority. But I'd still encourage you to save up some tiny sort of emergency fund, maybe $1,000, even before you go after debts like that. It's kind of silly to take your thousand dollars and put it toward a 29% debt, only to go out and take on another 29% debt. So theoretically, even a tiny emergency fund can help you as you adjust those major, major priorities as your financial life gets started. Now, how long do you have to really put it together? Well, the sooner the better. And the less you spend, and the more you make, the sooner you'll have your emergency fund. But I certainly think it's appropriate to try to get this emergency fund in place in less than a year. Less than a year after you come out of med school and probably your new, larger emergency fund within a year of finishing your training.
So try to put that together. You don't want to be saving up forever. If it takes you seven years to save up an emergency fund. I'm sorry, you're just not saving enough money. Because when you're done with the emergency fund, you're going to move on to other savings goals like saving for retirement or college. And if it takes you years to save up an emergency fund, you're just not going to be saving enough to reach those other goals. You need to find ways to boost income and decrease spending so you can get this in place. Where do you keep your emergency fund? Well, some people keep it in multiple places, right? Maybe some of it's in your checking account, maybe some of it's cash you actually keep at home, but the bulk of it is typically kept at some sort of institution that's actually going to pay you some interest on your emergency fund. A really popular place is a high interest savings account or a high yield savings account. And all that is, is a bank. And there's a number of them out there. Ally's a popular one, for instance, that'll pay you, you know, the going rate on money, whether that's 3% or 4% or 5%, they'll pay you something close to that. You don't want it sitting in a savings account to your credit union, paying you 0.1%, though you want it somewhere where it's going to pay you some interest.
Obviously, the return of your principal is more important than the return on your principal when it comes to an emergency fund, but at least get paid some simple interest while you're doing it. Some people might also keep it in a bank CD. Maybe they have it in a one year CD, and if you really have to rate it, yes, there's a penalty for that. You might lose a few months of interest, or maybe that keeps you from raiding it for silly reasons, and you earn a little bit more money on it than you would in a high interest savings account. But I think one of the best places to keep your emergency fund is a money market fund, available at Vanguard or Fidelity or Schwab, or someplace like that. Vanguard's funds usually have the highest yields, and that's where I have a brokerage account. And so that's where we keep our emergency fund, most of the time sitting in cash at a money market fund. And you can read that pretty easily, right? Within a day or two, it's back in your bank account and you can spend it. Yeah. It's good to have a little bit of cash on hand at the house, but usually within a day or two, that's plenty to be able to get to your emergency funds, especially if this is money you need to live on for one, two, three months.
Having to wait two days to get to it is not going to cause you any problems. Some people feel bad about the fact that they're only earning cash interest rates on their emergency fund. And the truth is, you shouldn't. Right. Because it's all about the return of your principal when it comes to your emergency funds. Don't get tempted to start investing this money into bonds or, you know, even into stocks you don't want to be finding. You need your emergency money, right? After a 40% drop in the stock market, this terrible bear market and you need to raid your emergency funds at the same time. You don't want that to happen. Leave it in cash. That'll allow you to invest the rest of your money more aggressively, and you'll make up for it in the long run. Just remember that the return of your investment is more important the return on your investment. Hope that's helpful. It's worth keeping an emergency fund for just about everybody. I mean, if you're a retiree and you already have millions sitting in your taxable account, that does function in some ways as an emergency fund. But even retirees typically keep a fair amount of money in cash that they can access readily without having to worry about market fluctuations. And that's what an emergency fund is.
The White Coat Investor Podcast is for your entertainment and information only, and should not be considered financial, legal, tax or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.
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