Do you think you could you pay your bills if you were unemployed for a few months? Where would the money come from if you were surprised by a large medical bill that you had to pay? These are the types of concerns that cause major financial anxiety for many individuals and families, and the solution is to have an emergency fund.
This crucial financial buffer serves as a safety net, providing peace of mind and protection against life’s unexpected expenses. These may include medical emergencies, car repairs, job loss, and many other unfortunate events. Despite its importance, there are varying schools of thought on how much to save, where to keep the money, and how an emergency fund fits into a broader financial strategy. In this article, we explore key aspects of emergency funds and provide direction to help you establish one that aligns with your goals.
HighPoint Advisors, LLC helps clients throughout all stages of life to get a handle on their financial future. Serving clients in Syracuse, NY as well as many locations across the country, we provide guidance on budgeting, debt reduction, saving & investing, as well as many other areas of financial planning for our diverse client base.
What is an Emergency Fund?
An emergency fund is a dedicated pool of money set aside to cover unforeseen expenses or financial emergencies. Its purpose is to be a buffer that provides stability in the face of financial setbacks. It can prevent reliance on high-interest debt, such as credit cards or other desperate measures, during challenging times.
How Much Should You Save?
There’s no one right answer here. Individuals have unique circumstances, so a few approaches exist:
- Bare Minimum: To address shorter-term spending shocks, some suggest starting with a small amount, like a half months’ worth of living expenses. This is meant to cover small items like a minor car repair, or a small medical expense.
- 3-6 Months of Expenses: To address bigger income shocks, it’s recommended to save 3-6 months’ worth of living expenses. This is meant to address life events like the loss of a job or an illness, for example. How much you should save depends on the specifics of your individual situation, such as your industry or the stability of your job. If you have a stable career with job security, you may decide to save only 3 months’ worth. Conversely, if you’re a freelancer or work for a non-profit, you may want to save 6 months’ worth.
- A Full Year of Expenses: Those with dangerous or high-risk jobs, sole breadwinners with dependent family members at home, or individuals that just want greater financial security may choose to have a war chest equal to a year of living expenses. This sounds like a big goal, but it also provides a big amount of peace of mind to those facing financial uncertainty.
What Type of Account Should You Use?
You need to be able to easily spend the money in your emergency fund if a crisis comes up, so liquidity and accessibility are key considerations. Looking at some of the more liquid options, a good place to start would be a high-yield savings accounts. Offered at most banks, credit unions, and online banks, these accounts are essentially a regular savings account that pays a higher rate of interest. There’s no extra risk, but they usually require a slightly larger initial deposit. Similarly, a money market account is another form of higher-yielding deposit account, and can also be found at most financial institutions. Money market accounts can also be bought in an investment account, and some even come with check writing capabilities.
Certificates of Deposit (CDs) are sometimes a good option as well because they offer a fixed rate of interest for a fixed period of time. You agree to tie up your money for a period of time, and in return the bank guarantees you a return on that money. Primarily issued by banks, these certificates are less liquid and usually range in duration from a few months up to a few years
While most advisors recommend keeping your emergency fund at a reputable financial institution, some individuals feel comfortable having physical cash on hand. Make sure this is stored securely in a safe.
How to Build Your Emergency Fund
First, set a clear goal that you will commit to achieving. Start small, and continue to grow it. If your goal is 6 months of expenses, and that feels overwhelming, just be patient and diligently make regular ongoing contributions until you reach that target. Try to increase the amount you’re saving over time.
An easy, yet powerful, best practice is to automate your savings. Set up automatic weekly or monthly transfers from your bank account into your emergency fund to make the process effortless. Consistency pays off over time. Plus, this is a good way to replenish your fund if you have to dip into it for an emergency.
Periodically, you may receive lump sums from various sources: bonuses at work, tax refunds, repayment of loaned money, etc. When these situations happen, consider putting part or all of those amounts into your emergency fund.
The Role of an Emergency Fund in Your Overall Financial Plan
Any financial plan that does not include an emergency fund is going to be vulnerable to unforeseen setbacks. Having a “safety net” fund will prevent the use of high-interest credit cards or other loans when a crisis happens. It will reduce the stress of unknowns and provide peace of mind so you can focus on your main financial priorities. The little shocks can be absorbed by your emergency fund, allowing you to concentrate on long-term investing and other goals.
An emergency fund also lets you be more confident in your financial decisions, because you know you have a certain amount of financial buffer built into your plan. Therefore, long-term investments shouldn’t have to be liquidated at inopportune times due to a crisis, which means they can stay invested and working towards your goals.
We Can Help You Decide
By choosing the right savings vehicle and contributing consistently, you’ll build a fund that provides peace of mind and safeguards your financial future. Regardless of your financial position, the key is to tailor your approach to your unique circumstances.
This article outlines a number of things to consider as you design your ideal emergency fund. Seeking the advice of a qualified advisor may be helpful to not only understand how such a fund will benefit your financial plan, but also how to incorporate that fund into other aspects of your plan. At HighPoint Advisors, LLC, we work with our clients to provide a range of options for safety and protection along the financial journey. An emergency fund is one tool in the financial toolkit needed to have long-term success in financial planning, and we’d be happy to help you set up your fund.
Contact us today so we can help to enhance your plan!