Emergency fund comes before investment?!

I shared my view on emergency fund in general earlier. At the end that post, I said that EF was a necessary step to start retirement savings and investments, without explaining it. This may seem to be a naïve question. However, I struggled with it when I got started and would like to share my experience here.

Emergency fund gives you a peace of mind which enables you to make better investment decisions. When I started to invest, I got several individual stocks, whose prices vary a lot. I intended to buy-and-hold, which was only possible when you are able to leave the money untouched even in emergency. It was quite tempting to use the emergency fund to buy more stocks. However, without an emergency fund, I realized that I might be forced to sell the stocks at the wrong time. So I need my emergency fund to take that risky investing strategy with individual stocks.

It became clear to me that it’s very important to separate your long-term investment and your cash reserve. When I first worked on my investment strategy, I had so many things in my mind, emergency cash, down-payment for the first house, regular investment, and retirement reinvestment. All these goals have different timeline, thus have different risk tolerance. Without separating them explicitly, I was really making the task much more difficult and even intractable. The good thing was that I was not paralyzed by the complexity, I started anyway; the bad thing was that I got a messy strategy which was not optimal and I had trouble sticking to it. In the end, I ended up selling all my holdings and reshuffled my portfolio in less than two years. I was lucky that I was a graduate student, thus, was not hurt that much in tax.

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Lower tax with Qualified Dividends and Capital Gain Worksheet

Today I was about to mail out my state tax return and saw a blank space in my schedule D line 22. It asked if I had any qualified dividend, which we did have. I was surprised Taxcut didn’t fill in this blank for me. So I decided to follow the instruction and take a look at the worksheet myself.

Dividends are usually taxed at the marginal tax rate of your ordinary income. However, take a look at the form 1099-DIV and you may find some of them are qualified dividends, which are taxed at the tax rate of long-term capital gain (15%).

Now the good news is that some people may qualify for an even lower tax rate at 5%. Please take a look at the following to see if you qualify:
1. If you have qualified dividends or long-term capital gains;
AND
2. If your adjusted gross income (AGI) is
less than $30,650 if single or married filing separately;
or less than$61,300 if married filing jointly or qualifying widow(er);
or less than $41,050 if head of household
Then you could lower your tax with the Qualified Dividends and Capital Gain Worksheet (Page 38 of 1040 instructions for 2006 and Page 35 of 1040 instructions for 2007) on line 44 of Federal tax form 1040.

I believe many graduate students and young fellows with lower income qualify for this. I used to be quite skeptical about usefulness of all kinds of the worksheets in 1040. This time, it really saved us hundreds of dollars in tax!