So, a series of recent events has proven to me that I can no longer get by without an emergency fund (I like to call mine a Freedom Fund, but I’ll call it an emergency fund for the purposes of this post). First, there were the bills I accrued from the death of my cat. Then, I experienced an incident with my car. It’s a long story, but I did some damage which ended up costing nothing to fix, but could have been very costly had I not been more lucky. Next time, I might not be – plus, my car is getting older and will probably start needing more frequent repairs pretty soon.
Bottom line: I need to establish an emergency fund ASAP.
For the record, it’s not as if I never planned on establishing an emergency fund. But I made maxing out my Roth IRA my priority for 2012 because if I really, really needed emergency cash and had no other option, I could tap it without taxes or penalties. At least, that’s what I always told myself. I’m realizing, though, that emergencies happen often and they can happen at the same time – digging into my Roth every time I get hit with a car problem or an unexpected medical bill could be disastrous in the long-term because the money needs to stay in the Roth to grow. I’m much better off having a stash of cash to tap in the event of an emergency, then focusing on maxing out my Roth. Which means, yes, I’m starting to agree with Dave Ramsey’s baby steps more and more. And yes, I’m counting this as a life lesson learned: having an emergency fund is not optional – it’s a necessity!
Anyway, I have two potential options for digging myself out of a minor amount of (interest free) credit card debt and establishing a $5,000 emergency fund by the end of 2012. I would really appreciate your opinion about which option to go with, especially because the second option is a little unconventional. Please, weigh in in the comments!
Option #1 – Traditional Dave Ramsey Methodology
If I take this route, I’ll stop my Roth contributions immediately, build up my $1,000 “baby” emergency fund, pay off the credit card, then build my $5,000 emergency fund. I could do the steps in this order by the end of 2012 because I have some extra cash coming in over the summer and I’ll be funneling the $417 per month that I had been putting towards my Roth towards debt repayment/cash savings. The benefit to this plan is that it isn’t very risky; this will make sense when you read option #2…..
Option #2 – An Unconventional Idea
Ok, hear me out on this one before you make a final decision: if I take this route, I’ll continue contributing the $417 to my Roth every month to max it out by December. I’ll use the extra money I have coming in to pay off the credit card. Then, at the end of December, I’ll transfer the $5,000 of contributions out of the Roth and into my savings account; I’ll never actually stop contributing to the Roth because at the point that I make that withdrawal, the emergency fund will be 100% funded and my credit card debt will be paid. So, in January 2013 I’ll just make my monthly contribution as usual, and will max it out just as I did in 2012. The benefit to this plan is that I have a whole year to earn interest on the contributions, so if I pull out those contributions in December, I’ll potentially have a few hundred dollars to start 2012 with, as opposed to the almost nothing I’ll be starting with if I stopped contributing immediately. Of course there’s always the risk that the market could take a serious dive and I could lose money, but in that case I’d just wait for it to rebound to make the withdrawal.
So what do you think? Which option would you choose? I want as many opinions as possible, so don’t be shy!