- Emergencies are not the time to worry about savings rates—if you have the money, use it.
- It’s recommended that you see if halting 401k contributions, HSA contributions, or student loan payments are right for you.
- Do not take out any money from your 401k unless you’re absolutely desperate.
- If you have variable income, build a buffer and plan accordingly.
On the last episode of ‘Money & Coronavirus: How Much Money to Save… ‘
Last time, we talked all about emergency funds, how to get one, why you should have one, and the psychology of saving your money. But, there’s a crucial component to owning your emergency fund—you actually have to use it when it’s an emergency!
Be honest, the pandemic is an emergency. It is 100% OK to use money from your rainy day fund—we just need to be smart about it.
Let’s go now to the psychology of using your emergency fund. I see a lot of people who have money saved up, but they are terrified to use it. This is the opposite of people who have a spending problem.
Don’t feel bad for spending your emergency fund
I hear a lot about these hyper frugalistas whose entire life is logging into their personal capital account and looking at it: “Oh no, I had a 29% savings rate last month, but my average is 33.3%. I’m really slipping. What’s wrong? I’ve got to get back on track because the community is not going to respect me enough. I need to get to 40%.”
Get a life. Please, do not end up on your deathbed feeling morally superior to other people because you have a 38% savings rate.
I have heard people still going to work even though they have a huge emergency fund account. Why? You ask them, “Why are you still going to work and exposing yourself and potentially exposing other people?” “Well, what do you mean? That’s my job.” Then you say, “Don’t you have a savings account you’ve been saving for like 10 years?” and they don’t make the connection. It’s called an “emergency fund” for emergencies.
Don’t you think maybe a global pandemic that has stopped virtually 100% of businesses across the world would be classified as an emergency?
If you’ve got the money, it’s time to use it. Use it to live. Use it to help other people. Remember, you can always refill it later, but the craziest thing is that you have people who have done the right thing and saved, but they never built the muscle of spending it.
It’s an emergency fund. If you need it, spend it. That’s the basic framework for how much to save right now.
What to do if you don’t have a emergency fund
Remember, one year’s worth of necessary expenses is my recommendation for how much should be in your rainy day fund. If you take a look at your numbers and you say, “You know what? That’s impossible, but I think I can do eight months over the course of the next six months,” pat yourself on the back.
What I want you to do is take action. I don’t want you to hear this number and get demoralized because you can’t do it overnight.
Part of money is its patience.
In fact, one of the biggest parts of earning a lot of money is being patient. In this case, you focus on what you can control, cut your expenses, earn more. Optimize your spending on all your bills. Call them up, negotiate, and take control.
401k contributions, student loan payments, and HSA contributions during COVID-19
One question I’ve heard recently: “Would you recommend halting or minimizing your 401k contributions, your student loan payments, your HSA contributions until we build up at least one year of an emergency fund?”
Yes, I would. Crazy to hear myself saying this, but yes, I would.
For example, your HSA contributions may be worth $10,000 over the course of the next 20 years. Okay, that’s a lot of money, but guess what? Today, in an employment scenario like this, I would rather have a couple thousand bucks now sitting in that savings account relative to $10,000 later.
Remember what I’m saying: You have to live to fight another day. If you have to take a little bit of a haircut on your $10,000 over the course of the next 30 years, it’s not a big deal. You can take the $2,000 that’s in your pocket and you can invest a little bit more aggressively next year or the year after, whenever things recover.
If you’ve got that one-year emergency fund, you have earned the right to keep investing your money and you will benefit drastically from that opportunity over the long term because you did the work ahead of time. For those of you don’t have that, focus on that first.
Should you take out the $100K with no penalty out of your 401k right now?
I would not do that unless it’s a dire case. I would say 50% of the time, I hear from people who took a loan against their 401k or pretty much took a loan, they never repay it. People who take loans out of their 401ks, in general, have poor behavioral control over their money.
Even though they’ve done some amazing things to be able to waive some of the fees and penalties that used to be there, unless you absolutely need to, I would not recommend it.
Why? A couple of reasons.
Number one, it’s a bad sign, overall. If you go raid your 401k it shows that you haven’t done the other things, like saving properly. For most people, the other things can actually sustain you.
Second, don’t forget I talked about all these things you can do: call up your credit card company, talk to your landlord, research unemployment. If you’re unemployed, take advantage of it, please. It’s there for you.
If you have to raid your 401k, then something has really gone wrong. Now, I’m not saying don’t ever do it, but it’s one of the sources of last resort. It might tide you over in the short term, but it will cost you dearly in the future. That money there will be highly lucrative to you in the long term if you can live to fight another day.
How do you save for an emergency fund if you don’t have a fixed income?
There are some guidelines for how much you can afford to spend on rent. In general, 28% is a good recommended number. These guidelines show how much people can spend on a rent or a mortgage, basically housing, a car, all debt combined, including student loan, credit card, et cetera.
If you have a variable income that adds an extra layer of complexity. The way that you do it is you want to build a buffer. If your minimum expenses are $1,000 a month, you want to target 6 to 12 months of emergency fund. In this case, if you have $5,000 a month, you take $1,000 away, pay off your stuff, put $4,000 in your emergency account, and then next month if you make zero, you can draw from there. In general, you want to build up a buffer and effectively simulate a standard 9-to-5 income.
Now, what does that mean specifically for you? It really depends on the numbers we’re talking about. If your variable income is $1,000 to $2,000 a month, that’s going to be a pretty low rent. Some freelancers, some months, make $30,000—then they make zero for two months.
In general, I would err on the side of being conservative. Look at how much you’ve made over the last year just as a benchmark and then I would take a steep haircut for the next 12 months, again, depending on your industry.
Closing thoughts on saving and spending money during emergencies
We dove way deeper than just cutting back on $3 lattes. We talked about the structure and how much you need to actually save.
The psychology of an emergency fund goes even deeper: what does it mean to build an emergency fund? A lot of people go, “That’s overwhelming. I can’t do that.” Do not give up. Even if you get 70% of the way there, it’s better than zero. You have to save money right now. You can achieve it—it will just take some time.
Finally, we talked about the psychology of spending. If you have an emergency fund, you have earned the right to deploy it. Spend it so you don’t have to go to work, spend it on your loved ones, and even continue investing if you have additional money.
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