Life happens, and you don’t want to be caught out financially. That’s why one of the first steps is to build up an Emergency Fund so that you are prepared for when things go sideways.
What is an Emergency Fund useful for?
This is money that will help cover any unforeseen events such as the loss of a job, a failed hot water heater, a car accident or repairs: anything that will create a big hit to your cash flow. If you don’t have any reserves, this can really set you back, so it’s critical to have some money set aside to handle these events.
How large should my Emergency Fund be?
The recommended range that you should have is anywhere from 2-6 months of expenses readily available. This is a pretty wide range, so you have to consider the factors involved for you. For big-ticket item failures (furnace, car repairs, etc), you want to make sure you can cover those quickly. So have enough to cover deductibles and other critical household items. Beyond that, the biggest factor will be an unexpected job loss or lack of work due to illness or disability. How “safe” is your job? How many jobs are out there in your industry; will it be easy to find another job quickly? Is your salary very regular, or have large swings? Are you a dual-income family? All of these can factor into the size of your emergency fund.
Another big consideration is the “sleep at night” factor. Are you very worried about your current finances and potential unexpected disasters? Or are you confident you can handle anything unexpected that comes up? Some people want to have more than 6 months of buffer ready. Just be aware as you have more readily-available cash, that impacts your long-term potential growth for retirement and other goals. Which brings us to….
Where do you put this money?
This money needs to be readily available in case of a emergency. You don’t want it to lose any value and you want immediate access. That could be a checking or savings account. Or a money market fund. Some money market funds even have check-writing against them so it’s really simple to get access.
Stocks or bond funds won’t work because they can lose value. CDs are an option, but you can have penalties for withdrawals. There are more complex strategies available such as using a home equity line-of-credit or laddering CDs or Bonds. Those give you higher yields on your money, but take more time to manage. So, for most, it’s best to keep it simple.
Build Your Fund
What if you haven’t started saving, or the amount you want to save seems overwhelming? Don’t worry, just get started with whatever you can spare each month. It’s way more important to get going, build some momentum and pretty soon you’ll be on your way. Open the account today! Set up an automatic transfer for each month so it’s taken care of. Maybe it’ll take a couple of years to get your fund built up - that’s OK - just get going today.
Re-evaluate Your Current Situation
Your situation changes over time. What was an adequate reserve in your 30s may no longer be sufficient in your 40s. Make sure to revisit your Emergency Fund strategy every so often and make sure it still aligns with your current situation.
How I personally handle My Emergency Fund
With all that said, I don’t have an emergency fund, per se. What!? My situation is that our family has stable jobs and I’m very risk tolerant. We have excellent credit and access to a home equity line-of-credit. I have part of my retirement portfolio in a taxable brokerage account, where I can get access within 3 business days. I prefer to keep money fully invested, but realize that if I need to sell off part of my portfolio, it may be at a loss - which can be substantial. I’ve had to do that for minor things in the past, and I continue to prefer the potential gains over the long run and not having a “drag” of cash. This is only possible because I’ve built up enough invested reserves to handle any small withdrawal/losses while we're a mid-career family.
This is definitely an option if you are in a similar situation. Be very aware of your emotions, risk-tolerance and personal situation to handle emergencies. I highly recommend that you contact a fee-only financial advisor if you're going to proceed with any advanced strategy or deviate from the generally recommended ranges.
The most important thing is to really think through your situation and come up with “what if” scenarios and make sure that you’re covered. Because life happens.