Guest Author - Reshma Vyas
How much is enough in terms of an emergency fund? Although many financial planners generally tout the standard line that everyone should have an emergency fund that covers 8 months of living expenses, this seemingly “neat” “one size fits all” type of advice is simply not valid in today’s current socio-economic climate. It is a fact that the current global economic and financial dynamics combined with shrinking job opportunities and stagnant wage growth in the United States are significant life-changing factors that should propel individuals to build as large a cash reserve as possible. In fact, building a cash reserve should serve two primary purposes: savings for unexpected emergencies and as a secure foundation for wealth-building over time.
Let us consider the emergency fund component of the overall cash reserve. What is an emergency fund? An emergency fund is “liquid” money that you can freely access in order to meet unexpected financial obligations. The money should only be withdrawn during a time of dire emergency. How much money should one ideally strive to accumulate in this fund? For a single individual, a minimum monthly budget of $1800 is not unheard of, even in a mid-sized city, and in a coastal city with an inordinately high cost of living, the amount would be considerably more! The individual in question would need to have an emergency fund of at least $21,600 to cover 12 months of living expenses. However, planning for an extra cushion of at least $6000 or more is crucial in order to meet any other unexpected emergencies that may occur down the road. Therefore, the ideal amount should be, at the very least, $27,600-$30,000.
How do I plan for an emergency fund?
In order to construct a realistic emergency fund for today’s economic climate, it is essential to consider 3 determining factors.
1. Debt and/or family obligations.
2. Employment prospects. How quickly will you be able to find a job that provides a salary that can adequately cover your living expenses and/or enable you to maintain your current lifestyle?
3. What, if any, additional sources of income can you tap if you should find yourself suddenly unemployed or confronted with a serious emergency?
Pay yourself first:
The ability to save consistently is the key to building a strong financial foundation. Make a concentrated effort to allocate a specific amount of money to your monthly budget that goes towards achieving your savings goal.
Where can I stash my money so that it is safe?
The recent banking failures have served as an unpleasant reminder that there is nothing in this world that is “truly safe.” However, most of us cannot really forgo having bank accounts; it would be highly unrealistic. Yet, aside from stashing emergency savings in a traditional bank account or bank money market deposit account ( Special note: this is different from a money market fund offered by a mutual fund company which is not FDIC insured.) to fulfill short-term financial needs, there are also other investment options. A high yield bank savings or checking account is one option; another alternative is buying short-term Treasury Bills. Before considering any investment, the guiding principal of investing for accounts that are to serve as your cash reserve, the emphasis should be on “safety over yield”. It is essential to possess a clear understanding of your risk tolerance and a thorough comprehension of the potential investment(s) in order to formulate a prudent strategy. The cash reserve you are building is not play money and should, hopefully, hold you in good stead during times of financial uncertainty and serve as a tool for wealth-building over time. Possible additional investment options in order to meet longer-term savings goals include government bonds such as U.S. Savings Bonds and Treasury Inflation-Protected Securities(TIPS), Zero-Coupon bonds, conservative fixed-income or income mutual funds and bond mutual funds including municipal bond funds. Before contemplating a move into any of these investments, it is vital to exercise due diligence and consult with a professional financial advisor. Laddering certificates of deposit may sound boring but there is absolutely nothing boring about receiving a guaranteed rate of return! A cautionary note to bear in mind is that certificates of deposits and/or money market funds that are marketed by financial or investment firms generally are not FDIC insured. If holding assets in an FDIC insured institution is of paramount concern, then it is absolutely crucial to verify all facts before even considering opening an account with the financial firm in question. It is also important to note that some banks are not FDIC insured and some credit unions are not NCUSIF (National Credit Union Share Insurance Fund) insured.
FDIC Bank Find,
National Credit Union Administration
Disclaimer: Information presented for educational purposes and not intended as investment advice.