Do you have the financial understanding to start yourself out on the right foot?
Financial Basics: Emergency Fund
An imperative part of any financial plan is a solid emergency fund. Everyone has heard that you need to keep an emergency fund, but how do you know how much to save and how to do it.
How Much Should I Save for an Emergency?
You have probably heard that you should save 6 months’ worth of expenses in an emergency fund. While the 6-month expense is a good guideline, it may not be right for everyone.
The 6-month guideline is generally for protection against job loss. In the event you lose your job, you have 6-months of expenses saved so you have the time to find yourself a new position without subjecting yourself to financial devastation. If your income is secure, then 6-months of savings may be too much. Are you retired with a pension? Do you have strong job protection such as a tenured professor or a union employee? In that case, you may be missing out on better cash utilization by sitting on a bunch of cash that isn’t earning enough for you.
For others, 6-months’ worth of expenses may be too little. Do you run your own business? Is your income unstable or sporadic? If you were to lose your job, would it be difficult or impossible to get another at your current income? If any of these are true for you, you may want to target your emergency fund for up to 12-months of expenses.
What Expenses do I Include in my Emergency Fund Calculation?
Once you’ve determined how many months of expenses you need to cover, you can calculate the dollar amount you need for an emergency fund. What expenses should you include? You should include any expenses that you are obligated to pay (such as taxes) plus anything that you will need to sustain yourself and your family such as food and utility expenses.
When calculating your emergency fund, you can leave out any unnecessary expenses such as entertainment, vacations, or saving expenses. Bottom line, it’s best to look at your whole expense picture, then cut out anything that’s unnecessary.
What if I can’t Save Enough for an Emergency?
So… just save enough to cover several months worth of living expenses- easy right? Ha! For most people, having the left-over cash for six months of expenses may take a long time. If that’s the case for you, don’t panic! An emergency fund based on monthly expenses is to cover yourself in the event of a job loss. A smaller emergency fund can still cover an unexpected expense such as car repair or a medical bill.
I advise folks who are intimidated by the monthly-expense emergency savings model to start out with a goal of saving $1000. This $1000 is an attainable goal that will go a long way to covering an unexpected expense. Once your $1000 is saved, then shoot to grow your emergency fund to $5000. A $5000 emergency fund is a solid foundation to then grow into eventually a robust fund that will cover a long-period of unexpected loss of income.
Where Should I Keep my Emergency Fund?
Your emergency fund should be easily accessible (liquid) and should not be subject to risk. The best place to store your emergency funds is in a savings or money market account. A savings or money market account will allow for some interest to grow but will still allow for the liquidity to access the funds quickly. Your emergency fund should not be invested in stocks or bonds as they will pose too much risk of loss.
Need more help with your emergency fund? Contact us at Old Growth Financial so we can help you get started for a better financial future today!