Emergency funds have been under fire recently. Once a bedrock principle of personal finance, the role of the emergency fund has evolved. Let’s look at the arguments for and against emergency funds, and see if medical students, residents, and/or attendings should hold these accounts.
Dave Ramsey, Suze Orman, And Emergency Funds
The standard advice of holding a 3-6 month emergency fund in cash was popularized by Dave Ramsey. It was Step 3 of his famous Baby Steps plan (Step 1 is to build a $1,000 emergency fund, and Step 2 is to pay off all debt using a debt snowball). According to a survey by the Federal Reserve and publicized in a famous May 2016 cover story for the Atlantic, 47% of Americans said they would not be able to come up with $400 to cover an emergency expense. Almost half of Americans have not even completed Step 1 of Dave Ramsey’s baby steps.
Suze Orman is even more conservative with her emergency fund recommendations. Her standard recommendation is an 8-month emergency fund. In some interviews, she has been recommending up to a 1-year emergency fund.
Personal Finance Bloggers Are Rethinking The Necessity Of An Emergency Fund
A number of personal finance bloggers have been rethinking the emergency fund, arguing forcefully that cash emergency funds are not necessary, especially for high-income professionals.
Josh at the Big Law Investor says that he has 6 months in expenses allocated in an emergency fund, but it is invested in Vanguard Lifestrategy Conservative Growth Fund (VSCGX).
Physician on FIRE also does not have an emergency fund. When emergency expenses occur, he puts expenses on credit cards, and he has an income and 15+ years of investments that can be used to pay off those expenses.
Early Retirement Now also has no emergency fund, arguing that he has the necessary money in credit card “float”, a home equity line of credit, and taxable accounts to cover any emergency. He also notes the significant opportunity cost of holding an emergency fund in low-yielding savings accounts.
So Who’s Right Then?
It would seem contradictory that respected personal finance voices have polar opposite opinions on the importance of an emergency fund.
However, the difference is that Dave Ramsey and Suze Orman are talking to one audience, while Physician on FIRE and Big Law Investor are speaking to a different audience.
An emergency fund is critical for the vast majority of Americans. Dave Ramsey is speaking to these people when he advocates for a $1,000 emergency fund. Remember that 69% of Americans have less than $1,000 in savings, according to a recent survey by Go Banking Rates. For them, the advice of Dave Ramsey and Suze Orman is sound. Complete Dave Ramsey’s first baby step of building a $1,000 emergency fund, and you are already ahead of the majority of Americans. Once you have that initial $1,000 in your bank account, building the 3-6 month (Dave Ramsey’s advice) or 8-12 month (Suze Orman’s advice) emergency fund is reasonable.
But Big Law Investor, Physician on FIRE, and others are speaking to a different audience. Their audiences are physicians, lawyers, and other high-income professionals. These people should be able to cash flow their way out of an emergency. For many, they are already at Dave Ramsey’s Baby Step 6 (pay off your home early) or Step 7 (build wealth and give generously). For them, I think it is reasonable to stop holding a cash emergency fund, since they have significant wealth to handle any financial emergency.
Emergency Funds by Phase of Medical Training
The role of an emergency fund evolves as you go from medical student to resident physician to attending physician.
Medical students – $1,000 Emergency Fund
Medical students should have an emergency fund. While they are taking out significant student loans, they should also hold a small emergency fund (probably in the $1,000 range as Dave Ramsey recommends in Baby Step 1) to handle unexpected expenses. The worst thing that can happen to a medical student is to accumulate credit card debt on top of hundreds of thousands of student loan debt.
Residents – 3-Month Emergency Fund
For the typical resident who has significant student loan debt, an emergency fund of approximately 3 months of expenses should be held in a liquid checking or savings account. Emergencies like job loss are rare (although occasionally residents will quit before finding employment in non-clinical medicine), but unpaid maternity leave or a medical leave of absence are reasons to hold an emergency fund.
Also, there are fixed costs that come up during residency that might present a cash flow crisis for residents. For example, in some programs, residents have to outlay thousands of dollars to pay for registration, hotel, and airfare to attend a conference, only to get reimbursed months after the conference is over. You want to avoid having cash flow issues to cover these “planned” emergencies.
You could probably get away with investing your “emergency fund” into the stock market, but for the amount of money we’re talking about here ($5,000-$10,000), the money gained between investing in the stock market versus keeping the money in a savings account will not make a big dent in your long-term finances.
Attendings – Emergency Fund Optional
Attendings, in my opinion, do not need an emergency fund. Taxable account or zero-interest credit cards should be able to handle any cash flow emergencies, as described by Physician on FIRE in his blog. Disability insurance should be able to handle any major health scares.
If an emergency were to happen, you would sell taxable account assets to cover your expenses. If money is needed for a shorter period than the 1 week required to get money out of a taxable account, you would use credit cards to cover the bill. Once the taxable account money hits your bank account, you would then immediately pay off the credit card balance before it can accrue interest.
After all, most of us use credit cards for everyday expenses and pay them off in full a month later. Instead of using your usual paycheck to pay off your monthly credit card expenses, in an emergency you would use proceeds from a taxable account to quickly pay off the credit cards.
To be clear, there is nothing wrong with holding an emergency fund when you are an attending physician or have substantial wealth. You can certainly have an emergency fund for your peace of mind. For example, an interventional radiologist wrote a guest post on Physician on FIRE earlier this year describing his reasons for holding a $500,000 emergency fund.
Remember that there is a difference between the finance decisions that maximize your money versus those that maximize your happiness. Some people will lose sleep at night if they don’t have money sitting in their bank account to cover their expenses should they get into a car accident or lose their job or get diagnosed with cancer. The emergency fund can reassure you that you will have money available to you very quickly in the event of an emergency.
Where to park your emergency fund
If you’re going to have an actual emergency fund, it should be in a high-yield savings account where you have instant access to the money. If the fund is in a total stock market index fund, or even a short-term Treasury fund, then I wouldn’t consider it an emergency fund per se.
High-yield savings account rates are rising, making emergency funds more attractive
Yields have been nil for many years in the years after the recession, but yields are ticking up slowly as the Federal Reserve increased interest rates. The high-yield savings account at Ally currently earns 1.15%. High-yield online savings accounts yielded 3% and higher before the recession and rates may eventually rise back up to that level in the future. I anticipate emergency funds will become attractive to people when yields on savings accounts rise.
Emergency funds should be liquid and easily accessible
The key thing about an emergency fund is access. Many people talk about investing their emergency fund in short-term Treasuries because they are low-risk investments. I don’t think short-term Treasuries are the optimal place to put emergency fund money because these bonds do fluctuate in value (recently in a good way), they pay lower interest rates than high yield savings accounts, and the money is not immediately accessible. Stick to a high-yield savings account for your emergency fund.
Emergency funds have been out-of-style recently because of the rock-bottom interest rates paid by savings accounts, but I expect they will become more popular as interest rates rise. Medical students and residents should have an emergency fund, but attendings should be able to cash flow their way out of any emergency using money from their taxable accounts. However, it’s always completely reasonable to have an emergency fund of 3-6 months living expenses for your own peace of mind.
What do you think? Do you have an emergency fund? If so, where do you park the money for your emergency fund?