Save for Now -- and for Later

With a fat emergency fund, this high school teacher can also afford to start a Roth IRA.


Emeka Diribe, 27

Fullerton, Cal.

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Should I build my emergency fund or invest more for retirement?

When the economy began to unravel, Emeka decided he needed to save more. His goal: to sock away cash in case something happened to his job (he's a high school math teacher). So Emeka started an emergency fund and has built up a stash equal to six months' worth of expenses in an online savings account with ING Direct. Meanwhile, Emeka, who is single, is accruing retirement benefits in the California teachers' retirement system. But now, as he looks at his savings -- which also include several thousand dollars in stocks -- he's wondering whether he's doing enough. "I'm trying to find the right mix," he says.

About 20,000 teachers were laid off in California last year, and Emeka wants to squirrel away as much as he can. Should he bulk up his emergency-fund savings to cover a year's worth of expenses? He could open an IRA, but he says he doesn't like the idea of tying up his money. And he'd like to have money to buy a house someday.

Emeka is off to a good start. If the past two years have taught us anything, it's the importance of having financial reserves and living within our means. He chose well by putting his savings in an ING account. ING has no maintenance or withdrawal fees, and it pays 1.3% interest, which is higher than the rate the average money fund pays.

But does someone who is young and single need an enormous emergency fund? Teaching may not be a lucrative occupation, but it's more secure than most jobs. Emeka should think about two issues: how long it would take to find a new position if he needed to, and whether he would feel more secure with a bigger buffer.

Usually, being able to cover three to six months' worth of expenses is sufficient. But with jobs hard to come by, a larger stash makes sense. "If he has a year's worth of savings and he loses his job, he won't have to take the first offer that comes along," says Michael Eisenberg, of Eisenberg Financial Advisors, in Los Angeles. (See "How Much Cash You Really Need".)


Once Emeka fattens his fallback fund, he should concentrate on retirement savings. He'd benefit from opening a Roth IRA, to which he can contribute $5,000 in 2010. His money will grow tax-free, and he can withdraw his contributions without a penalty if he needs the money before retirement. Plus, having a Roth will diversify his retirement savings.

Herb Montgomery, a financial planner in Orleans, Mass., uses the following example. Two friends, Jeff and Susan, join the same firm at age 22. Both aspire to retire in 40 years. Susan immediately opens a Roth IRA, contributes $5,000 a year for ten years, and stops. Jeff waits until he's 32 to open a Roth, but then invests $5,000 a year for 30 years. Assuming an 8% annual return, at retirement Susan would have $787,000, and Jeff would have $612,000. Susan's head start is worth that much. The lesson for Emeka: The benefits of tax-deferred savings outweigh the chance he'll be sacked from the classroom.

Associate Editor, Kiplinger's Personal Finance