Authored By Ryan Frank | Principal, SC&H Financial Advisors, Inc.
When it comes to financial planning, proactively preparing for life’s unexpected events is crucial to achieving your financial goals. While predicting future turbulence in your life may be impossible, there is a way to better protect yourself in the case of a financial emergency so that it does not negatively impact your financial plan.
From unemployment or a sudden medical crisis to major home or car repairs, an emergency fund can provide peace of mind when you are faced with unanticipated expenses. No matter where you are on your financial journey, it’s never too late or too early to start an emergency fund.
What is the Intention of an Emergency Fund?
An emergency fund is money set aside to cover life’s unplanned expenses, allowing you to live comfortably, even when you experience a shock to your income or a large expense. The fund should be able to carry you through a few months until an emergency is resolved. An emergency fund will help mitigate the risk of going into debt while you work through the matter, sparing the need to use credit cards or pull from your savings to cover expenses. Here are a few common situations people face:
- Job loss
- Medical or dental emergency
- Unexpected home repairs
- Car troubles
- Unplanned travel expenses
What Are the Characteristics of an Emergency Fund?
An emergency fund is for a TRUE emergency. The money should be accessible, but only used when you face real financial difficulty.
- Your emergency fund should be kept in a readily accessible location where you don’t have to worry about fluctuations in market value.
- The money in your emergency fund should be liquid so that you can access it at any time. It could be in a checking, savings, or a money market account like a high-yield savings fund.
- Although you’ll earn a low rate of interest, this money is meant to be your safeguard in case of emergencies.
- This money should not be used for daily spending or one-off items as it is not a delayed spending account.
How Much Should I Save For an Emergency Fund?
When you start saving for your emergency fund, pick a target amount, begin working toward it, and adjust your emergency fund savings amount as your financial situation evolves. While there is no steadfast rule or dollar amount that works best for everyone, generally you should maintain roughly 3 to 6 months’ worth of your gross expenses. For example, as your obligations grow financially, the amount you contribute toward your emergency fund should also increase. Whereas, if you are retired, you may not necessarily need the same size fund you had while working full time and raising a young family. As your expenses increase or decrease, ensure your emergency fund does the same.
Pro tip: Automate your savings so that a set amount is transferred into your emergency fund every paycheck. That way, you’re saving without needing to give it thought.
How Does an Emergency Fund Fit into My Financial Planning Approach?
Your financial objectives will be more successful if you have an emergency fund. It serves as a safety net, so you don’t have to rely on using money that was set aside for long-term financial goals and investments.
When you have an adequate emergency fund in place, you have the flexibility to invest your other resources into investments that you’re not reliant on in the short term. The money you put into other long term, growth-focused investments can then accept more price fluctuations because you don’t need it to potentially cover expenses incurred from an emergency.
Pay Off Debt While Building Up an Emergency Fund
There is a balancing act between building an emergency fund and paying down short-term consumer debt, which includes credit card debt, personal loans, and other high-interest debts. Here are some tips on how to address existing debt while you build up an emergency fund:
- Don’t ignore debt to build an emergency fund.
- Pay down debt first, especially when it comes to high-interest credit card debt, as this kind of debt can cause a lot of problems elsewhere in your savings.
- As you pay off debt, re-allocate those payments to build up your emergency fund faster.
Determining the Appropriate Assets to Pull Out of the Market to Drop into an Emergency Fund
The money that you currently have invested for long term growth should not be relied upon in the short term and, therefore, should not be considered part of your emergency fund. When financial hiccups are experienced in the market, sending a shock wave through your investment portfolio, long term growth focused investments may dip significantly. But, if left alone, these assets will have the time to bounce back because you will not be using them in the short term.
While assets that are invested in stocks have the potential to experience far more growth over time than money in a savings account, your ability to access the latter at a moment’s notice, without fear of a temporary value decline, takes precedent.
Stick to Your Goals
While it may be tempting to use your emergency fund money because it is accessible, don’t touch it. Do your best to avoid the temptation to use money that is meant to keep your livelihood intact while you experience an unexpected expense. Remain disciplined about saving toward your fund goal.
Here are three tactics to build your fund:
- Automate money going into an account that you don’t track often. You can do this by having an amount automatically deposited to your emergency account when you get paid.
- Avoid having checks or debit cards made for the account so you are not tempted to withdraw from it on a whim.
- Remember to focus on long-term success, not temporary, material gains.
Many resources will tell you how much you should save in your emergency fund without knowing your expenses or financial situation. We believe that the amount you save in your emergency fund can only be decided by talking with a financial advisor who knows or is committed to getting to know you and your financial goals.
At SC&H, our Financial Advisory professionals assess your personal situation, the state of your finances, and any possible debt. We take into consideration your goals and plans to give you a curated answer to how much you should save in your emergency fund.