The Automatic Millionaire by David Bach - Chapter 5 - Automate for a Rainy Day

In the 5th chapter of The Automatic Millionaire, Bach discusses the necessity of putting money aside in case of emergency; whether the emergency be a job loss or medical bills. He calls this the “sleep well at night” factor. Most people live paycheck to paycheck and many families depend on 2 paychecks to make ends meet. He credits his grandmother with telling him when he was younger, “when the going gets tough, the tough have cash.” We may not be able to prevent bad things, such as a job loss, fire or flood damage, or becoming disabled, from happening to us but we can protect ourselves financially by having a cushion of money available (and, although he does not mention it, appropriate insurance).

Bach sets up 3 rules for setting up your emergency fund. First is to decide how big a cushion you need. He recommends having at least 3 months worth of expenses set aside (note this is not 3 months worth of income). Although he says more money can be put in this emergency fund, I disagree. Your regular investment account can be tapped after three months. This emergency fund is to give you liquidity in case of emergency. Your regular investments should be earning a better return than your emergency fund and should be accessible within 3 months of the emergency, if needed.

The second rule is not to touch the emergency fund. This money is for true emergencies. He compares it to a fire extinguisher that should be used only in case of fire not every time you think you think you smell smoke. He describes a real emergency as something that threatens your survival — not just your desire to be comfortable.

The final rule is to put this emergency fund money in the right place. The money needs to be earning a decent return and regular savings accounts and suitcases in the back yard just won’t cut it. He suggests shopping for the best money market rates at regular local banks as well as at online banks or to use government I-Bonds. He gives a list of online banks that would be worth looking into and does warn that some banks have minimums required to open a money market account but many will let you open an account with a smaller amount if you have money direct deposited into it. The problem I see with the government I-Bonds is that they have penalties for early withdrawal, so investigate these carefully before using them.

In the course of his discussion he suggests putting at least 5% of your salary away each month towards this rainy day fund. There is no discussion if this 5% is in addition to the 10% minimum he suggested for your retirement fund or if it is done in lieu of retirement planning until the fund is built up. Again, I think his emphasis is so much on the “Automatic” in the title, that he is not really worried about making a coherent, step by step plan.

Along this same vein, Bach mentions, almost as an afterthought, that you should not ignore your credit card debt while building up this emergency fund. Instead he says you may want to set aside just one month’s worth of expenses until you are able to get your credit card debt paid down. I think that Dave Ramsey is more on track in this area, just $1,000 set aside until you are able to get those pesky credit cards paid off.