Why you need an Emergency Fund (and how to maximize your retirement savings at the same time)
Everyone needs an emergency fund. As Forrest Gump wisely informed us all: Shit Happens. Whether that's a car accident, a run in with the law, your pet getting sick, or, god forbid, the death of a family member. Having an emergency fund allows you to weather the storm in these stressful situations without the additional long term stress of going into debt. We in the military are lucky that we have a few of the other, more common fears covered for us such as healthcare and housing issues. However, we still face the single most important reason to keep an emergency fund: job loss. Our careers are considered extremely stable by civilian standards, but you never know when the next RIF might happen and there's the possibility you won't make it past your next board.
Commonly, it is recommended that you keep an emergency fund of between 3 and 12 months of expenses in liquid assets. That means savings, checking, or money market accounts. Expenses should not include vacations, eating out, entertainment, or anything else discretionary. It's called an emergency fund because it provides the necessities for you during an emergency. In my case, 6 months of the bare minimum comes out to about $10,000. I would have to drop my online entertainment subscriptions, my Brazilian Jiu Jitsu gym membership, all eating out, and stop buying stuff off Amazon, but this would keep me housed and fed along with access to transportation and communication in the event I did not have any income for 6 months.
This is all standard advice. I've seen it parroted on pretty much every personal finance blog and in every personal finance book I've read. The next part is where it gets cool, though. Most personal finance 'experts' will tell you that you should prioritize an emergency fund over maximizing retirement savings. What if I told you that you could do both?
You can. One of the beautiful things about the Roth IRA is that it is post tax. That means that you do not have to pay a penalty on withdrawing principal. If you are just starting out on your Financial Independence journey, you might only have enough money to start filling either an emergency fund or an IRA of $5,500/year. I recommend that beyond a basic buffer of $1,000 in immediately accessible funds in your checking account, you put the rest of your emergency fund in your Roth IRA in a money market account. Money market accounts are federally insured like savings accounts, so there is almost no risk of losing your money and you won't see too much in the way of gains right now since interest rates are so low whether you keep your E-fund in savings or money market. As time goes by and you have enough money to fund both your IRA and your E-fund, you can start converting your IRA holdings into investments. You can't go back and fill your IRA for the previous year once April 15-17th comes around. That means if you prioritized your E-fund and didn't have an emergency, you missed out on $5,500 of tax advantaged space. If you did have an emergency, you would have been covered either way.
The only downside is incredibly minor in comparison to the massive upside-you won't see any growth of your E-fund. This is ok. Your E-fund isn't an investment, it's self-insurance. That said, you might as well use this strategy to get the best of both worlds while you're starting out. You can check out a cool case study with more math on the bogleheads wiki: https://www.bogleheads.org/wiki/Roth_IRA_as_an_emergency_fund