The (Tiered) Emergency Fund – The Bedrock of Wealth Building

“It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.”- Robert Kiyosaki.

This may seem like an unusual quote to initiate a post regarding a personal emergency fund…but I assure you it is quite fitting. The emergency fund is cited countless times by personal finance professionals and from some of the best minds in finance for a reason: it is that important. It should serve as the bedrock of your personal finances and efforts to build wealth. Anyone who says otherwise either knows nothing about money or is trying to sell you something.

The Emergency Fund is a separate account created by an individual in case of the event of a personal financial dilemma. Such situations may include job loss, auto repairs, illness, or home repairs. The purpose of the fund is to provide a blanket of security by creating a safety net of funds to meet such expenses; as oppose to drawing from high interest debt (such as credit cards) or personal loans. Essentially, it is a very powerful insurance policy to possess and combat the financial expenses that are unforeseen. However, I like to take things a step further. I believe this insurance policy should not only combat unforeseen expenses, but it should be ready to combat financial expenses that are foreseen in the future. In addition, the emergency fund can be constructed into tiers representing various asset classes (equities, bonds, and cash) to form not only a buffer for expenses, but a buffer with the ability to grow on its own to build wealth itself.

It is widely debated as to whether the Emergency Fund should be invested or just held as cash. I think traditional advice states that the fund should be 100% cash. However, this is dangerous because inflation will eat away at this cash. In addition, as long as the fund is tiered responsibly and with diversification, it can be expected to generate a return while serving its main purpose of fending off unforeseen expenses. I also want my emergency fund to be able to cover investment contributions during the time frame of choice. In doing so, during a time of lost income, I can still make investment contributions if I choose.

My Tiered Emergency Fund Goal: $xx,xxx
• 6 Months of Expenses
• 6 Months of Investment contributions
• Anticipated rental property expense

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1. Tier 1 (High Risk): 40%: Wealthfront Portfolio Risk Level 10 
Wealthfront is a popular robo-advisor. This risk level portfolio consists of US Stocks: 35% / Foreign Stocks: 22% / Emerging Markets: 28% / Dividend Stocks: 5% / Natural Resources: 5% / Municipal Bonds: 5%.

2. Tier 2 (Low/Medium Risk): 40%: T. Rowe Price – Mix of Mutual Funds 
T. Rowe Price is a popular choice for individual investors. I have selected four funds that range from mid-level to low-level risk profile. When combined, these four funds possess multiple assets classes including equity, bonds and cash. Overall, the equity potions contain large cap stocks and the bond portions consist of low risk notes.

3. Tier 3 (No Risk): 20%: Cash 
I keep 20% of the emergency fund holdings within cash.

It is important to remember that the emergency fund should be liquid and should not hold a tremendous amount of risk. Although, some may say that the above structure does contain more risk than the average emergency fund…and I would have to agree. But that does not mean that the emergency fund itself is risky. As long as the fund contains 6 months (or whatever period you choose) of funding, I will be able to sleep at night. In addition, if my risky tier (Tier one) drops in value, I can continue to solely fund this portion of the fund to take advantage of dollar cost averaging and maintain a strong position. While the other two tiers should not drop in value considerably enough to sweat it.

Another important point is to mention that one should always monitor their emergency fund and update it as life progresses. Therefore, you will always have this buffer to serve as an insurance policy…no matter how expensive life gets. As planning for huge expenses such as children, housing and education become important…it will be important to include these variables within your emergency fund. As a result, all other assets, that you hopefully own, will be able to continue to grow while you keep expenses accounted for.

Key Take Away Points

1. Tier Your Emergency Fund: tier the fund to possess different levels of risk exposure.
2. Emergency Fund Should Cover Foreseen & Unforeseen Expenses: this approach will ensure that you are covered safely.
3. Emergency Fund Should Cover Investment Contributions: this approach will ensure that you are still able to contribute to your assets while perhaps you are suffering a job loss or if you lose your primary income source.
4. Monitor Emergency Fund: this will enable you to constantly have the designated amount of your choice. It is important to stick with the emergency fund amounts. If it is depleted, it must be re-filled.
5. Feed Emergency Fund: by constantly feeding your emergency fund, you are able to build the established buffer. As a tip, one should strive to constantly feed the aggressive portion of their tiered setup. As long as this tier consists of appropriate holdings, such as index funds or diversified allocations, you can confidently build wealth and your emergency fund simultaneously.

Having an Emergency Fund is essential to building wealth and to your personal finances. However, agreeing with traditional wisdom to hold 100% of your emergency fund in cash is dangerous and counterproductive.

Let your Emergency Fund work for you.

Redefine.

-James