Frugal Dad's Tri-Level Emergency Funds
(Revised 6/5/2017)

A tri-level emergency fund is the ultimate way to diversify your cash portfolio dedicated to emergencies, and when fully funded, should help you sleep better at night. It's been said that there is no softer pillow than money in the bank. After many sleepless nights in the past with an empty bank account, I would have to agree. Emergencies can and do happen, and when they do, you may be forced into an expensive solution like credit cards or personal loans and in extreme cases having to declare bankruptcy.

Indeed, half of Americans had experienced an unforeseen expense in the past year, according to a 2014 survey by American Express; of those, 44% had a health care-related unforeseen expense and 46% had one related to their car both of which tend to be things you can't avoid paying. According to a survey of 1,000 adults released by in 2015, nearly one in three (29%) American adults (that's roughly 70 million) have no emergency savings at all, the highest percentage since Bankrate began doing this survey five years ago. What's more, only 22% of Americans have at least six months of emergency savings the lowest level since Bankrate began doing the survey. These findings mirror others all of which paint an abysmal picture of Americans ability to withstand an emergency. For example, a survey released in March by national non-profit NeighborWorks America also found that roughly one third (34%) of Americans don't have emergency savings.

To build emergency funds from scratch, start an automatic transfer to a savings account and set a task to revisit and increase the amount in a month, says Robert Schmansky, the founder and a financial adviser at Clear Financial Advisors. See how much you can increase the amount until it becomes noticeably impacts your spending budget and then stop.

Frugal Dad Tier I Emergency Fund
$500 to 1 month's expenses in green cash
Fire proof safe bolted to concrete floor in closet or basement
The first $500 of so of your emergency should be something completely liquid (green cash) and saved within arm's length. This amount could be spread out around hiding places in your home, your car, or at your job (or some combination), or could be locked down in a fire proof safe bolted to the concrete slab in your closet or in your basement. The point is to stash some cash to cover short emergencies that may happen when writing a check, using a debit card or a credit card, or visiting the ATM is not possible. Think state-wide power outage, a local natural disaster, a house fire, a major terrorist attack, etc. Don't keep your life savings tied up, but stashing a few hundred dollars makes sense. (The 5 Best Places to Hide Emergency Cash at Home.)
Frugal Dad Tier II Emergency Fund
$1,000 to 1 month's expenses in local bank checking account
Bank must offer Debit Card, have ATM, and have a local branch within short walking or driving distance
The next $1,000 of your emergency fund should be kept in a savings buffer/emergency fund at a local bank or local credit union checking account. These funds would cover things like car repairs, broken appliance repairs, a family member needing to be bailed out of jail or in desperate need of cash, late-night calls to the local plumber, etc. The beauty of these accounts is they are local and have check-writing privileges from a local bank, so most service providers in your area would not give you a hassle about accepting a check. If they did, a quick trip to the ATM, or a cashier's check from the local branch should resolve the problem.
Frugal Dad Tier III Emergency Fund
6 to 36 months of living expenses

What's a "mega emergency"? Mega emergencies are the types of emergencies that might require you to live off this fund for a short time. Think job layoff, medical disability, a serious accident, etc.

Frugal Dad's mom suffered an aneurysm and stroke about a year ago and had to wait six months for disability insurance to begin coverage. Are you prepared to live six months without any income? Most of us are not, and unfortunately, neither was she. Almost one-third of Americans entering the work force today (3 in 10) will become disabled before they retire according to a 2007 Social Security Administration report. You can't collect Workman's Compensation for being disabled if you were injured when not at the workplace.

Almost one-third of workers who lose their jobs don't collect unemployment insurance according to a 2011 Unemployment Insurance Administration report. You can't collect Unemployment Insurance if you quit, were fired for cause, or are not fit to work. In general, there's a 10% probability that any one of us could lose their job in any given year, according to the Bureau of Labor Statistics. Those numbers, of course, are skewed during recessions and economic hiccups like we've seen in recent years. In these cases, according to the BLS, more than 10% of those who are jobless need more than a year to find employment. If you depend fully or partially on sales commissions for your income, a prolonged sales slump may seriously impact your finances.

Ideally, you should have an estimate for the smallest amount you'd be able to live on month-to-month. That includes housing, food, clothing, transportation, health insurance, and essential liabilities (utilities, loan payments, etc.) Add those up to get the sum of your monthly expenditure.

You also need an idea of how long you might be without income. One way to do so is to multiply your monthly minimum spend by your re-employment period (the number of months it might take you to find a new job.) According to the most recent July 2013 data from the Bureau of Labor Statistics, the average (mean) duration for unemployment in the United States was was 37 weeks (round up to 10 four week months). That could be more or less depending on your industry and skills.

Here's a simple formula to get you started:   Monthly expenditures * Re-employment period = Baseline safety net amount

Some financial advisers recommend each partner in a couple hold separate liquid assets equal to at least 6-12 months' living expenses in his or her individual name only (in case of a breakup or divorce), and I encourage new couples to consider holding on to these sort of safety nets. Be upfront with your significant other about it and encourage him or her to do the same. In the best relationships, these emergency funds foster equality and respect for the other's independence. In less ideal circumstances, they give each partner a personal life-vest should the unexpected occur. In short, it helps ensure that both partners stay because they want to, not because they have to.

The average consumer will never face an emergency that requires him or her to come up with six months to twelve months of salary within 24 hours. That's why some advisers suggest keeping the emergency fund partially in conservative, liquid bond investments for the money that you would tap into in the event a catastrophe overwhelms your disaster cash.

Many financial planners recommend that retirees who own stock or stock mutual funds in their retirement investment portfolio should keep 3 years of cash in reserve in case of a stock market crash. The 3 year reserve of cash will allow avoiding liquidating stocks for living expenses at the bottom of the market and will give the stock portion of the retirement investment portfolio time to recover from the stock market crash. Since 1926, it has taken an average of 3.3 years for stocks to surpass their high set before the typical bear market began. Some experts recommend no or minimal cash reserves but recommend instead to liquidate bonds for living expenses in case of a stock market crash. However liquidating bonds for living expenses will potentially distort your permanent asset allocation thus increasing your portfolio risk level as well as depriving you of rebalancing resources at the bottom of the bear market.

If you do decide to keep a large emergency fund, be sure to deduct any guaranteed income you will receive over the period such as net Social Security, net pensions, net annuity payments, net IRA Minimum Required Distributions, etc. For example, suppose you are a retired person who wants a 36 month emergency fund. You determine you need $100,000 in emergency funds over that period. Suppose also that you receive $1000/month in net Social Security and $20,000/year in annuity payments. Then the guaranteed income you will receive over the 36 month period will be $36,000 from Social Security and $60,000 from annuity payments. This totals $96,000 over the 36 month period. If you subtract the guaranteed income you will receive over the 36 month period from your $100,000 emergency fund requirement ($100,000 - $96,000 = $4,000) you calculate you only need a net $4,000 invested in emergency funds.

For a healthy young person with 30 years to retirement, there is little reason to have a 36 month emergency fund. As you get closer to retirement, you should start moving some of your investments over to the emergency fund. You should start this phase five or 10 years before retirement. And you could gradually grow your emergency fund from, say, 12 months to as high as 36 months, depending on your risk tolerance. Keep in mind, over a 30-year sample, cash provided a lower return than stocks 73% of the time. If you've got a long time and want to generate returns, cash is a drag on your total portfolio returns.

Merriman Emergency Fund
6 to 12 month living expenses
Each mutual fund below has a $3,000 minimum to open.
Sweep the interest from VFSTX into VMMXX
to simplify income tax preparation
Excel spreadsheet of Lazy Portfolios and their performance track records.
Vanguard Prime Money Market First 3 to 6 months expenses VMMXX 50%
Vanguard Short Term Investment Grade Bond Second 3 to 6 months expenses VFSTX 50%

Lazy Portfolio Advice Proposed High Yielding Emergency Fund
12 to 36 month living expenses
Each mutual fund below has a $3,000 minimum to open.
Sweep the interest from VFSTX, VIPSX, and VFIIX into VMMXX
to simplify income tax preparation
Excel spreadsheet of Lazy Portfolios and their performance track records.
Vanguard Prime Money Market First 3 to 9 months expenses VMMXX 25%
Vanguard Short Term Investment Grade Bond Second 3 to 9 months expenses VFSTX 25%
Vanguard Inflation-Protected Securities Third 3 to 9 months expenses VIPSX 25%
Vanguard GNMA Bonds Fourth 3 to 9 months expenses VFIIX 25%

Buckets Total Return Approach