Sumo-sized emergency funds: Are they necessary?

by Pop on January 22, 2010

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Or, “Unemployment Benefits: Family Style”

O.K., you need an emergency fund — let’s get that out of the way. Having cash for minor catastrophes, like a catalytic converter that goes kaput or the high deductible on a medical bill, is essential. This story isn’t about that.

But lately, I’ve been questioning the conventional wisdom as to how big the fund should be. Emergency funds are a hot topic right now. Companies are still bleeding jobs, and the average length of unemployment hit 29 weeks in December. Unemployment insurance in many cases covers less than half of what you earn. And since the job market is so poor, personal finance pubs and blogs have recommended upping your emergency fund to a year’s worth of expenses. That’s tens of thousands of dollars sitting in a cash equivalent account.

I’m really lucky. I have a pretty tight-knit family, and each of us are financially solid. I know my parents have a significant emergency fund, I have a year saved up, and my brother—who just started work—is building his up. Between the four of us, that’s literally hundreds of thousands of dollars earning next to nothing.

I faced a minor emergency a few weeks ago that required dipping into my fund. But my parents also offered to help out. I know if my brother faced a problem, both my parents and I would be there to help. This doesn’t even account for the emergency funds of my grandmother or cousins. Just counting my immediate family, we probably have 24 months of living expenses saved (that’s if I became unemployed). My entire familial safety net could probably cover more than five years.

So are our emergency funds really too big?

The job market’s bad. But do we really think my dad, brother, and other relatives face a significant risk of losing our jobs at the same time? Pretty unlikely. So why not just ditch the pretense and establish a “family job insurance plan” that would cover any of us if we lost our jobs?

The concept is not so different from that of traditional, employer-based health insurance. Different parties pay different premiums based on their incomes. You establish a high deductible—say, above $2,000. So the collective fund only covers a huge emergency such as an extended job loss. You still keep your own, personal emergency fund for minor problems, like a blown tire.

For the sake of convenience, and since we all already have our own emergency funds, we’d probably just lump parts of our emergency fund together. Its total size would be a little larger than two-thirds our current total, with the goal being the ability to cover two of our incomes disappearing for a year. And the extra money that we save by not having as large an emergency fund as we used to have can go in a higher yielding, but more risky investment that wouldn’t have been appropriate if the funds were marked for an emergency.

I haven’t quite worked out how I’d structure “claims” once someone does need to draw on the fund. Like unemployment insurance or disability insurance, I’d probably want to make payouts that improved the unemployed family member’s standard of living but didn’t completely make up for their lost income. That would increase their incentive to keep looking for a job. Once they’re employed again, I’d probably also want to structure premiums that would return the emergency fund to full power quickly.

Anyway, this idea might seem out there, but it starts to paint a picture of emergency funds far different than the gigantic slush funds most personal finance press and blogs suggest you build up. Indirectly, it also makes you more accountable to keeping the emergency fund for emergencies only. I’m not going to let my parents or brother dip into the fund for a new car. They wouldn’t let me do that either. Whereas if I was in charge of my own fund, I’d be more likely to slip up now and then.

I’d be interested to hear if anyone else has considered how their “social” safety net makes the traditional emergency fund less important than at first blush, and if anyone’s tried different tactics to address it. WiseBread has other ideas as to why you might make you fund smaller.


{ 5 comments… read them below or add one }

Moom January 28, 2010 at 9:57 pm

Well I know I can borrow money from my mother as a last resort. I’ll never end up homeless. But it is the last resort usually. Whether your idea will work depends on how responsible/reliable family members are. Will they really pay back the money they took out? Or will they keep putting it off etc? In the latter case this will result in family disputes. It all depends on how much you trust each other or maybe not trust but knowledge about responsibility.

Pop January 29, 2010 at 12:01 am

Hey Moom,

Thanks so much for commenting. Yeah, I totally agree. And like I said, I’m lucky that my family is pretty well organized financially right now. Sometimes I wonder if there could be a service to formalize a family emergency fund somehow, much in the same way that Virginmoney tries to formalize loans that friends and family make to each other. I bet a lawyer could write it up, but the money spent on him would probably negate the benefits of pooling the emergency fund together in the first place.

WellHeeledBlog February 8, 2010 at 6:11 pm

This is an interesting way of looking at unemployment insurance, but I’m not sure if it’d work. What happens if 2 people in your family loses their jobs at the same time? Or one after the other? In this economy, especially if they are in volatile industries, this scenario might not be so unlikely. I have a big emergency fund and I’m approaching 6 months unemployment. I wouldn’t do a family-style emergency fund just because there are too many land-mines dealing with family and money, especially during a stressful time such as unemployment.

Pop February 8, 2010 at 6:41 pm

Hey, thanks for the comment. You’re right. If everybody loses their jobs at once, you’re in trouble–just the same way that if an insurance company insures a bunch of houses on the Florida coast and a hurricane comes, they’re in trouble. Just as an insurance company spreads out its risk across geographies, I’d want to make sure my family worked in diverse industries before setting something like this up.

You can “what if” yourself to death though. If I said, “Have a years worth of expenses saved up,” someone could respond, “But what if you’re unemployed for two years?” All we can do is set up an emergency fund that factors in the probabilities of unemployment length, and if it’s a family fund, the probabilities of people losing their jobs at the same time.

Thanks for making me think that through more! Good luck in your job search.

K Smith April 10, 2010 at 2:48 pm

Promoting the idea of a family job insurance plan assumes that such arrangements do not already exist. They do. Growing numbers of families are already helping each other in every way they can, including using emergency funds. When they run out of money they are moving in with each other.

If your goal is to be debt free, it makes sense to have an emergency fund to cover not only loss of income during unemployment, but also unforeseen expenses such as high dollar car or home repair. And given the upcoming changes in credit card regs, when card issuers will be able to charge sky high rates, it seems foolish to plan to go into debt to cover these kinds of expenses. Having an emergency fund set aside to cover them makes much more sense.

I don’t view emergency funds as giant slush funds. I view them in much the same way as real estate investors set aside a portion of their operating budget for replacements and reserves. Even in the best of times, unforeseen things happen. Plumbing breaks. Transmissions die. Teeth decay and need root canals.

We are all now living in times of great uncertainty. During times of uncertainty, the likelihood of becoming a victim of unforeseen circumstance increases. Companies continue to announce layoffs. Last week our Treasury Secretary Mr. Geithner said, “The unemployment rate is still terribly high and it’s going to stay unacceptably high for a long period of time.”

In our current environment it seems foolish to advocate reducing an emergency fund. It seems to me that prudence in uncertain times of protracted high unemployment would dictate setting aside a bigger emergency fund, not a smaller one.

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