Emergency Fund
Why do you need an emergency fund?
An article at bankrate.com outlines in great detail as to why an emergency fund is required. A few of the unexpected financial cracks are
1) Car breakdowns / repairs
You never know when your car is going to breakdown. You cannot anticipate this. Though you might have car insurance, you might have to pay a minimum deductible before your insurance covers the rest. This minimum can range from $100 to $2500.
2) Losing a job
Both me and my husband hold high tech jobs. So there is always a chance of losing our job with the market fluctuations. We need to have a reserve that totals to atleast 6 months of our household monthly budget.
3) Last minute travel emergencies or vacations
We don’t put aside money for travel. So when we plan our vacations, it would come out of that month’s income. We would try as much not to touch our emergency fund.
4) Medical emergencies
I haven’t faced one. But I would like to have about $10,000 for medical emergencies.
5) Safe feeling
I personally look at investing in stocks and mutual funds as a long term investment. So when the market fluctuates and goes south, the emergency fund would keep me from making any impulsive decisions to buy or sell any stocks.
How much money in an emergency fund?
Including the above categories, the amount that we are comfortable for the emergency funds is $50000.
Where should you have the emergency fund?
1) 3-month CD : I do not prefer this one because I will not have access to the account for 3 months. For me this is not ideal for an emergency fund. Also online savings account offer almost the same interest rate as those of 3-month CDs.
2) short term bond fund : Same as the 3-month CD
3) High yield savings account : I pick this because of the ease with which I can access the money and also because of the competitive interest rates.
When to use the emergency fund?
This is a habit I want to emulate from my father. He saves money for a future event expected and unexpected. But when the event occurs, he tries as much not to use the emergency fund. He tries to cover it with that current months income. I think this is the best way because it is very hard to set aside money. I would prefer not saving anything for one month than touching what I have already saved.
My goal for year 2008 looks at filling 80% of our emergency fund. The rest would go towards reducing our debt. It is a conscious choice that we made. Any extra income that we receive would be funneled into our emergency fund. So if everything goes better than we estimate, we should have our emergency fund completely funded by end of year 2008.
The 4-0-1-(k) story
I had planned to write about our budget analysis today. But I changed my mind since I had to think about our 401(k) investment yesterday evening.
After a really long period of requests to my husband to sign up for 401(k) at work, he did it yesterday. We had to make decisions about where we wanted to invest the contributions. His employer uses Fidelity. The website was simple and very user friendly. We could get around to do what we wanted in the first few minutes. I think they had a good mix of different mutual funds to choose from. The mutual fund categories that we had to choose from are large blend, large growth, large value, mid-cap blend, small blend, small growth, moderate allocation, conservative allocation and foreign large value. There were 2 bonds.
When I saw that we can invest our contributions and the company’s contributions in different ways, I immediately came to the conclusion that I would choose aggressive investing strategies for the company’s contributions and safe investing strategies for our contributions.
The first thing I did was google for ‘401(k)’ and the following are some of the links that I read:
1. How 401(k) Plans Work
2. About 401K Plans
3. 401(k) Articles
From what I read, there were 2 things that I wanted to remember while choosing my mutual funds: diversification, loads and expense ratios.
We made a list of all the mutual funds available. We gathered information about their expense ratios, investment splits(% of investment in cash, stocks etc), morningstar risk and return categories and their top 10 holdings for each of the funds. The list was:
1. Fidelity Contrafund
2. Fidelity Equity-Income
3. Fidelity Spartan U.S. Equity Index Inv
4. T. Rowe Price Growth Stock
5. T. Rowe Price Personal Strat Growth
6. Vanguard Mid Capitalization Index Ins
7. Lord Abbett Small-Cap Value I
8. Vanguard Explorer Adm
9. Vanguard Small Cap Index Instl
10. Morgan Stanley Inst International EqA
11. T. Rowe Price Personal Strat Balanced
12. T. Rowe Price Personal Strat Income
From the available mutual fund categories, we decided that the company’s contribution would be split like below:
Large cap mutual funds 55%
Small cap mutual funds 15%
International mutual funds 15%
Bonds 15%
From our list of mutual funds, we eliminated those that does not belong to one of these categories. None of the mutual fund options that were offered by fidelity had any loads. So didn’t have to make up my mind there.
Next we compared the expense ratios of the mutual funds in each category. Except in one category, I picked the ones with the lowest expense ratio. The exception was because the mutual fund’s top 10 holdings had Google and Apple. Though the expense ratio of this fund was higher by 0.2%, I was okay with that. So here we go, the list of the mutual funds we picked and the % contributions:
1. Morgan Stanley Inst International EqA 15%
2. Fidelity Spartan U.S. Equity Index Inv 25%
3. Fidelity Contrafund 30%
4. Lord Abbett Small-Cap Value I 5%
5. Vanguard Explorer Adm 10%
6. Bonds 15%
Do you think this is a good choice? Please share your 401(k) experiences.
