You’ve handled plenty of medical emergencies, but could you manage a financial one?
Young professionals are often urged to begin building an emergency fund of six months’ worth of expenses in a nonretirement account. But it strikes some as counter-intuitive to park money in a low-yield savings account while paying off medical school debt at rates of 5 percent or 6 percent.
And once established with a growing net worth, particularly after getting a late start saving for retirement, others can’t justify keeping a large chunk of money out of the financial markets when it could be invested.
Remo-tito Aguilar, an orthopedic surgeon in his third year of practice in the Philippines who writes a blog about his own and other physicians’ finances, says he was one of those debt-averse professionals. “I paid my debts before I even realized I needed an emergency fund,” he says.
Creating the blog as a way to educate himself on financial issues, Aguilar has since built cash reserves to the six-month level. It sometimes shrinks to three to four months, which he says he’s comfortable with because he’s single with no dependents and feels confident in his ability to stay employed.
Financial pros acknowledge the reluctance to stash away cash when it could be put toward reducing higher-interest debt, but many say the absence of an emergency fund is a bigger risk. Physicians are often urged to keep even more money in an emergency fund than their counterparts in business and law, because of their higher incomes and sometimes longer hiring processes. “Particularly in the earlier years in your career, I’d be very wary of exclusively paying down debt,” says Joan Crain, senior director for BNY Mellon Wealth Management’s Florida offices.
Building toward even the basic six-month rule of thumb is a fine strategy early in your career, says Crain, but there are different ways to get there and beyond, depending on your risk tolerance.
The early years are when emergency funds have the least flexibility, says Crain.
Don’t succumb to the notion you can do without one and simply rely on a home-equity loan or even credit cards in an emergency, she says. The mortgage and credit crisis wiped out that easy money for all but the most stable credit-risk customers.
Instead, create a budget that includes paying down the minimum payments on your student loans, credit cards, and mortgages. With the income left over, prioritize any high-interest card debt and getting those reserves built. If you’re comfortable with those amounts and still have income left over, put down extra payments on the student loans next, experts say.
What if you actually need to use the money? These are the years when you begin to define how sacred the emergency fund will be. Nearly everyone underestimates what they’ll need for living expenses, so these funds have a tendency to disappear, says Scott Munkvold, an adviser with FSA Advisory Group in Chicago.
“We try to get a dialogue going with clients that gets them thinking about planning for the worst-case scenario,” says Munkvold. “When you’re starting out, you’re more susceptible to emergencies and have fewer resources should something come up. At this stage, most people need to worry a little less about paying down debt so they can keep some liquidity. If you pay down the house, you may not be able to get it back with lines of credit being pulled away.”
Where should you stash the money? Both experts recommend strict cash accounts, preferably protected with FDIC insurance. Certificates of deposit are an option, but keep at least some of that completely liquid for smaller emergencies to avoid early-withdrawal penalties.
By mid career, you’ve hopefully built your savings beyond the emergency account and are now investing those dollars for growth. How should you think about the emergency fund now?
“At this stage you should be socking away as much as possible for retirement,” Munkvold says, not to mention college and other big expenses that crop up in the peak earning years. So you may actually have less in actual cash reserves than you did before. Not to worry, he says, because your higher level of assets provides you with some options.
Now your career and other assets likely will put you in a strong position to have a fairly large home equity line of credit, at least $100,000, he says. And your income can also be a cushion, because (again, hopefully) you can redirect fewer paycheck dollars into savings if a true emergency does come up.
At this stage there are also some alternatives to traditional savings accounts and CDs. Munkvold’s firm uses funds such as the Eaton Vance Floating Rate Fund (EABLX), which invests in loans and other debt securities, and exchange-traded bond funds that invest in municipal bonds and other credit markets. The instruments provide a dividend yield that typically exceeds the cash markets without taking on large amounts of risk, Munkvold says.
You can also explore cash alternatives such as CDs linked to a stock market index, but advisers recommend extreme caution about these complex products. Among their drawbacks are often penalties for early withdrawal that actually reduce principal, which is exactly what you don’t want in an emergency fund, advisers say.
Heading into the home stretch of your career, hopefully you’ve amassed a portfolio large enough to withstand an emergency, even if it meant selling some stocks designed as long-term investments. And as you approach retirement, more of those assets will be in fixed income-type investments such as bonds, which can act as your emergency fund, advisers say.
Even clients at this stage need to keep some powder dry, however, Munkvold says.
“We always keep some cash available, if nothing else than for having some on hand to take opportunities in the market,” he says. “It’s maybe $50,000 to $100,000 on a portfolio of a couple of million dollars.”
Sound like too much — or too little? Crain says spouses frequently disagree on how much to keep in reserve, with women typically wanting a bigger safety net and fewer stocks. Having a conversation about how much to put in the fund — and why it fits your current life stage and overall investment plan — can help, she says. “At the end of the day you want a figure that lets you both sleep at night.”
Janet Kidd Stewart is a freelance writer based in Marshfield, Wis. As a contributing columnist for the Chicago Tribune, she writes a weekly, syndicated retirement column called “The Journey” that appears in Tribune newspapers across the United States. She holds a bachelor’s degree and master’s degree from the Medill School of Journalism at Northwestern University. She can be reached via [email protected].
This article originally appeared in the March 2010 issue of Physicians Practice.