How to get through unplanned events without breaking the bank.
An emergency fund is the cornerstone of any solid financial plan. How much you should put in that emergency fund will vary depending on your circumstances, but having one in place will protect your financial future against minor emergencies and major setbacks.
One Saturday morning last month, my wife noted that there had been some trouble with the ice coming out of the ice maker. It wasn’t ice. We noted that a few of the items in our freezer were no longer frozen. After she mentioned that there had been beeping from the refrigerator the night before, I thought that the freezer had been ajar through the night leading to the issue. We closed the door, discarded the melted ice cream and went away for the weekend trip that we had planned.
According to a Fed Survey, (1) 40 percent of American adults don’t have $400 to cover an emergency. Whether it be a medical bill, auto repair, or household issue, many things can lead to unexpected expenses. What if the bill were bigger? Would you have the money to handle it?
When we returned from the weekend, my wife checked the temperature on our refrigerator. The freezer thermometer read 69 degrees, the refrigerator 77. We spent the next half hour throwing out 300 dollars’ worth of food.
We were fortunate. We live in a rental building where the landlord provides appliances. As a result, our refrigerator was quickly replaced at no cost to us. Replacing our refrigerator could have cost us $2000 or more. For those on tighter budgets, that kind of expense could be very difficult to handle without significant changes to their lifestyle in the short term.
The most basic element of a financial plan is to make sure you have an emergency fund.
Typically $400 isn’t enough for an emergency fund. Most emergencies will cost more than a broken refrigerator. What would you do if you lost your job? How long would you be able to live with the cash you have?
There are many opinions about how much should go into an emergency fund. Some experts say as little as a couple thousand dollars is adequate, while others suggest you need up to a full year of expenses set aside. The answer depends on your situation. How stable is your income? What makes you feel safe and secure?
One of my clients, a retired woman on a small, fixed income, feels most comfortable with over a year’s worth of living expenses available. She was grateful for that large emergency fund when unexpected medical bills hit. Others just want more cash on hand because they are fearful of a liquidity event, such as an older parent needing money despite their high income.
The primary purpose of your emergency fund is the loss of income.
Whether you are laid off or have to leave your job due to a disability, the income you receive from an unemployment check (which is taxed) won’t go far. You need a large enough emergency fund to deal with unemployment before tapping into investment funds. The loss of a job is always scary, but it will be more or less scary depending on the size of your cushion. Will you have enough money to maintain your health insurance and pay basic bills until the next position comes along? And what if one of those household emergencies happens while you are not employed? How will you handle that given your likely tightened budget?
Any financial plan must have an emergency fund in conjunction with making contributions to long-term investments. Without one, you will likely run into problems that will adversely affect other elements of your plan.
Key takeaways
The basic element of a financial plan is an emergency fund.
The primary purpose of your emergency fund is to supplement a loss of income, whether from layoff or disability.
Starting building your fund month by month – it takes time.
Set incremental goals so that you can work towards your long-term goal without putting too much stress on your current lifestyle.
The minimal emergency fund should be 3-6 months of your income.
Consult with a financial professional if you have questions or need help figuring out how to get started.
If you need help building your emergency fund, set up a call and we can help you build one and put you on a better path.
Russell D. Rivera, CFA®, CFP®, is the Founder and President of Voice Wealth Management (Voice). He considers himself as a Personal CFO and Financial “Therapist” for entrepreneurs, young professionals, and their families. He helps clients make prudent financial decisions regarding spending, saving, investing, and planning while giving a voice to the individual client's financial priorities and experiences. Get in touch with Russell at 646-630-0980 and voicewealth.com.
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