3-6 months of living expenses?


Personal-finance experts often recommend having 3-6 months' worth of living expenses saved and easily accessible. In his July 1, 2007 Getting Going column ("Popular Advice You Shouldn't Take"), Wall Street Journal columnist Jonathan Clements offers alternatives to a cash account (e.g., savings account or CD). He's got practical ideas that relate to how people really think, live, save, and invest.

Let's consider why experts make this recommendation so you can develop a personal-finance Plan B.

The primary reasons experts recommend cash reserves are 1) to pay for emergencies or unexpected, non-budgeted expenses such as medical bills or major home repairs 2) to pay regular expenses (e.g., your rent or mortgage, food) if you become unemployed, disabled, or lose income for some reason. They want you to avoid financial unpleasantness that may haunt you for years to come:

  • Bad: you have to pay for emergencies using credit cards with high interest rates; you have to sell your mutual funds, ETFs, or stocks, during a market downturn.
  • Worse: You have to pay tax penalties for withdrawing funds from your 401(k) or tax-deferred account.
  • Catastrophic: you have to declare bankruptcy; you lose your house to foreclosure.

Try to prevent or calmly, wisely deal with financial emergencies:

  • Don’t go a day without health insurance, especially now that the insured get discounts not typically available to the uninsured;
  • Get an estimate of costs ahead of medical bills and start setting aside money before the bills are due (In my experience, healthcare providers are slower than other vendors in forwarding bills as they often wait for insurance reimbursement before requesting payments from consumers);
  • Ask for a payment plan from vendors (When I was in my early 20’s, my dentist offered to let me pay a small portion monthly until my balance for extensive dental work was paid in full; my childhood dentist didn't believe in novacaine so I avoided dentists while in college);
  • Buy disability insurance;
  • Have your home inspected or do a home inspection yourself, figure out what items need to be replaced or fixed before they completely disintegrate, and start planning for major home repairs now;
  • See if your homeowner’s or renter’s insurance can cover unusual expenses.

Note that there are scenarios where losing your job wouldn’t be financially catastrophic:

  • You have a spouse/significant other who can cover regular expenses (which means, most likely, that you have purchased much less house or less car than you can afford by lenders’ standards or you have a high-earning spouse/significant other);
  • You can adjust your living situation easily (e.g., move in with your parents while looking for another job or recovering from an injury);
  • You work in a field and/or live in a market that makes finding a new job with pay comparable to your current one relatively easy (but if your company compensates you extremely well compared to its competitors, start socking away money now!)

In Popular Advice You Shouldn't Take, Mr. Clements suggests these alternatives to saving cash:

  • fund your 401(k) to receive company matches and tax benefits;
  • save some money in a conservative, taxable account;
  • open, fund, and, if necessary, access contributions to a Roth account (your contributions can be taken out without tax consequences although earnings generated from the investments can not be used without penalty; see this article on the Roth)
  • make a down payment on a home using funds you've saved by not having traditional cash reserves, and then
  • take out a HELOC (home equity line of credit), which should carry a lower interest rate than a credit card.

Please know that Mr. Clements and I do want you to set aside money now for future use; we just want you to consider investing your money rather than putting funds in accounts with low returns. When you can enjoy the fruits of not spending (buying a home, getting company-match dollars, growing your portfolio), you'll be motivated to keep on saving and investing.

(edited for placement of link to Mr. Clements' article)

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Guest's picture

excellent advice, i have been slowly saving this up, its easier said then done

Guest's picture

When my sister-in-law got pregnant 8 months ago, the hospital told the couple to expect to pay $10,000 on top of insurance. A month later, with no insurance, they were told it would be about $4,500. Insurance discounts, my ass.

Guest's picture
Chris Carpinello

Fantastic idea about treating a Roth IRA as your emergency fund!

Julie Rains's picture

I'm not selling health insurance just reporting on what I've read in the Wall Street Journal, heard about from a friend, etc. Also see: http://www.topix.net/forum/health/appendicitis/TAPDC8S544BO5UMD0

btw, my eye doctor did give me a discount for being uninsured (for eye exams); of course I was paying right then (he didn't have to wait for insurance payments) and we go to the same church.

Guest's picture

The ultimate irony for me: I now pay far less for health care and prescription medication than I did when I was employeed full time at a Fortune 500 company with a full benefit package. Back then, I had to pay $50 monthly out of my paycheck for the healthcare portion of my benefit package. I also had a $25 co-pay for all office visits, and a $100 co-pay for any hospital or medical procedure.

Now, without medical coverage, my doctor deeply discounts my office visits. I pay $50 a visit. My doctor also gave me 2 months of my prescription free because she had samples from the drug company. She also told me to call ahead when I ran out of the meds, and if she had more free samples she would give them to me. I have yet to pay for the prescription. Under my former health plan, I paid $25 a month for the medication.

Here is the ultimate kick in the pants. I had to have a colonoscopy (this was when I had full health coverage). My doctor arranged for it with a gastro Dr. and it was scheduled within a matter of days. Several weeks after the procedure, I received a bill for $1000. I disregarded the bill, thinking the insurance company was delayed in paying it. The bill kept coming, though, and I finally called my insurance company. They denied the claim because they had not been notified prior to the procedure. I was stuck with this bill. I was infuriated. I called the Dr.'s office and explained what was going on. They immediately cut the bill to $350. I paid it - grudgingly.

Because of my experiences above, I am convinced that the problem with health care in this country is not the doctors, it is the insurance companies. The doctors I have dealt with seem to prefer cash customers, and offer substantial discounts to cash customers. I paid far more when I had so called "full coverage" under my former employers health plan.

Julie Rains's picture

Thanks for your stories. Where I live, it seems that the physicians/offices (most of which are owned by the large healthcare organizations) let the insurance companies drive their practices rather than the other way around (and this does drive me crazy). For example, I was looking for a dermatologist not too long along and I was debating between two, both of which I had heard good things about. One was listed on a website with skin cancer info so I called and asked to make an appointment. I was told that I had to have a referral from my physician, who had told me to see a dermatologist if I was concerned about a certain skin spot (which turned out to be innocuous) a few months earlier. By the time I paid for the primary doctor's visit, any money that I would have saved on my medical insurance from getting the referral would have been cancelled out. The dermatologist #1, I suppose, wanted to make sure that she would get paid by the insurance company. I didn't try to convince #1's office staff that its policy was silly, unprofitable, and counter-to-preventive medicine, so I went with the other dermatologist.

My concern, though, is that someone would build up a nice-sized portfolio and then suffer a major illness (cancer, heart attack), and lose their investments to pay for medical bills.

I have heard that medical illnesses are a leading cause of bankruptcy but here's an interesting study that suggests that lack of coverage (rather than initial lack of insurance) is the culprit.