There is an interesting discussion about this on "Get Rich Slowly" - Is it Possible you don't need an Emergency Fund which started me thinking about our own situation. What kind of emergencies could we encounter? - fire, flood, pestilence (a plague of pigeons :-))? but anything catastrophic of this nature would be more than likely be covered by insurance. Medical emergencies figure heavily for Americans - according to Lisa's figures they represent the most common financial emergency, but they shouldn't cause so much concern to UK citizens. (However who knows what the future might bring regarding the NHS. As an aside one of the main reasons we would like to have a fair amount left to pass onto our sons is that they both have an inherited medical condition that could mean they have periods when they can't work in the future, or need drugs that the NHS will no longer supply. This worry and the threat of the possibility of one or both of us needing care home support is why we would like to leave our ISA funds in tact for as long as possible - so maybe this is a form of long-term medical emergency fund in itself.)
Our emergencies are most likely car, white good or kid related. I do not count holidays as an emergency (although taking one sometimes is :-) - probably not so much the case when you retire). Holidays, despite being paid for in chunks of cash, will continue be paid for by credit card when we retire and have been accounted for as part of our day to day expenses. Thinking about what has happened in the past and when we have unexpectedly needed cash it has generally been to make loans to the kids (some paid back, some not) for things like clearing student overdrafts, help with rent deposits and prop-ups so that they could complete their education. We have not (as yet) joined the growing number of parents who have helped their kids with buying a house but several of my friends have. If we do go down this route though it won't be an emergency. So, in the past the kind of figure we would be looking at that we might need at short notice could be up to around £3,000. In certain situations this could happen maybe 3 times a year - major car repair, fridge and telly both pack-up and the dog needs an operation. This semi-educated guesswork gives me a figure for our own particular emergency fund of £12,000 going forward. I'm happy with that, it can continue to sit in our "high" interest Santander 123 account and hopefully seldom get touched.
But that's not the whole picture. In addition to this I do have to look at the bits of our income post retirement that aren't guaranteed. From when I retire at 58 and until I'm 66 and my state pension kicks in not all our required income will be coming from guaranteed sources. We will be relying on our rental income and dividends from our ISAs to make up between 30% (58 to 60) and 15% (60 to 66) of our £30,000 income. Neither of these sources are sure-fire or inflation linked. They are liable to fluctuate and may not always be available, or we may not always want to take them. In the case of the rental income we may have an extended void period or large repairs that eat into the rent. (I do only ever assess the annual income from the flat on 10 months' worth of rent but I want to be super careful here). In the case of the ISA dividends we might want to take advantage of a market drop to plough them back in and buy when things are cheap, rather than depleting the funds when they are low. In these situations extra cash in the emergency fund might come in handy.
Given that between £4,500 and £9,000 of our income over those 8 years is not entirely secure, it probably makes sense to have at least a years' worth of the average required (£6,750) available in the emergency fund. This should be added to my original £12,000 and can all be fitted into the Santander 123 giving a total emergency fund of £19,000.
So, I have my figure, we need a £19,000 cash emergency fund until I am 66 when it can probably be run down slightly. Getting the cash into the fund is doable - we currently have just under £14,000 as we've just used some cash to change the car. Making up the extra £5,000 won't be a problem over the next few months before my husband retires. The question that bothers me is how to keep it topped up once we have both retired and are maxing out our income. The whole point of the fund is that it will get used - although it would be nice if it didn't - so how do we fill it back up to comfort level when it does?
The only solution I can think of is to make a point of moving any capital gain from the ISA into cash as and when it becomes available? I have been doing a bit of rebalancing recently using a couple of funds that have made over 25% gain, sold some stock and bought more of assets I'm still a little low on. Should the same strategy be used to keep an emergency fund at the required level? It certainly makes sense from a "sell high" point of view and the whole point of the emergency fund is to avoid a situation whereby you are forced to sell when stocks are low. Of course the potential for more growth is lost by moving down into low interest cash but you are at the same time dodging the bullet of real loss if you need to sell at wrong time. I'm proposing the following sequence of events:
- Son needs help with the airfare and living expenses for interview and then relocation in Toronto (this might actually be happening which is very exciting :-) He's just finished his PhD and is applying for a research position there.)
- Remove £5,000 from the emergency fund
- Check ISA for any funds that are showing signs of good growth (this is independent of any ongoing asset rebalancing that is going on).
- Sell an appropriate amount of any funds that are showing more than a pre-defined amount of growth (15%, 25%?)
- Top up the emergency fund
- If everything in the ISA is showing red do nothing, wait but rebalance ISA annually as usual if necessary. Wait. Wait. Hope emergency fund holds out despite deciding to use cash from it instead of taking dividends out of the ISA during the bad patch. Wait.
- Breathe sigh of relief as markets start to rise again. Wait for strong growth and eventually take some profit and rebuild the emergency fund.
Any other ideas anyone?