No one ever expects to lose their job, have an accident or have their primary source of income suddenly disappear. Unfortunately, without proper planning a small speed bump could turn into a major road block. Setting up an emergency fund can ensure that you cruise over the speed bump as smoothly as possible.
What is an emergency fund?
An emergency fund is an amount of money that is set aside in cash to fund your living expenses in case you are unable to meet them. It is not money that is to be used to purchase that brand new TV. It is meant to pay for non-discretionary expenses when you are not able to do so with your wages. When will you need to use funds from the emergency fund? It can happen at any time.
Why do I need an emergency fund?
You may lose your job and suddenly, your source of income dries up. Or maybe you get hurt and can’t go to work for 3 to 6 months and you don’t have a short-term disability policy to supplement that income. In the absence of an earning spouse or other alternative sources of income, you could find yourself in a dilemma. Without sufficient funds in cash, you might need to liquidate your investment assets or sell some of your personal assets. In short, lack of sufficient emergency funds could mean huge losses, tax bills, or other unintended financial setbacks.
How much cash is adequate in an emergency fund?
This common question doesn’t have a definite answer. The “industry standard” advice is to keep three to six months of your living expenses in an emergency fund (savings account). The amount you need to save in your emergency fund depends upon several factors. How many sources of income are available to you? If you are single and your earnings are your only source of income, you may want to consider having at least 6 months of expenses in an emergency fund. If you are married with a working spouse, you can consider reducing your fund to 3 months of expenses in cash. There are also other factors that could warrant a higher emergency fund such as:
- No short-term disability coverage
- Inadequate health insurance coverage
- Seasonal or uncertain employment
Everyone’s needs are different when it comes to their personal emergency fund, but working with your financial advisor can determine what would be best for you.
I have my money invested, does this count?
An emergency fund is different from investing. Emergency fund saving means keeping money aside in your bank accounts. This is usually kept in cash and is readily available. This money can also be kept in highly liquid and marketable securities such as certificates of deposit (CDs), money market accounts, or savings accounts. These accounts earn negligible rates of interest and are easily converted to cash without a loss in value should a need arise. Investing, on the other hand, means, using your saved money to buy securities or other assets (such as stocks, bonds, or rental properties) with the intention of making a profit in the future. In case of an emergency, you may be unable to convert them to cash quickly enough or may face a loss in value. Thus, emergency fund savings must be different from long-term investing.