ALL THINGS EMERGENCY FUNDS
Let’s start with defining an emergency fund, which is simply money put into a liquid and accessible account to cover unbudgeted and unforeseen expenses. Many call these accounts “rainy-day funds” or “savings accounts,” but they all serve the same purpose. The two broad categories for accessing these funds would be a job loss/large pay cut or significant surprise expense(s).
What type of account is the best fit for an Emergency Fund?
There can be multiple appropriate answers to this question, but one incorrect answer is your primary checking account. Even if you manage money well or are not a big spender, extra money in your regularly used checking account will dwindle and be used for non-emergency purposes. So having a separate, rarely used account will guard against eroding this vital part of a solid financial plan. Some good examples are money markets, interest-bearing savings accounts, and brokerage accounts. Although you do not want it to be your sole emergency fund option, utilizing a short-term CD or I-bonds could be an option for a portion of your account. The account should be liquid, and no penalties or fees to access the funds, but you purposely don’t want to make the funds too easy to spend. So, if you do a savings account as your emergency fund, doing one at a separate bank apart from your checking account is a good idea.
How much should I keep in my Emergency Account?
There are two “stepping stones” of Emergency Funds, which come into play as to where you are within the Baby Steps. If you live paycheck to paycheck or have debt(s) to be paid off, try eliminating any discretionary spending until you get to at least $1,000. This is Dave Ramsey’s first step in the seven financial Baby Steps and is an excellent way to develop the mindset of living below your means and establishing an emergency fund that may go up and down occasionally but never totally goes away.
Once you have paid off all your debt (outside of your mortgage), establish a 3-6 months emergency fund. This emergency fund should be calculated using expenses versus income to know what is needed to cover mandatory living expenses. We know the difference between three to six months of expenses can be a large number. Determining how much you need is dependent on your specific situation.
The rule of thumb is that if it is a dual-income household or both of your jobs appear very stable and are salaried, a little closer to three months should suffice. If you are on a single income, your job(s) is unstable, or you are self-employed with a fluctuating income, you should try to save for up to six months’ expenses.
Should I invest my emergency fund?
The hope is that you never have to touch your emergency fund. If you purposely set up an account outside of your primary or only checking account, it should allow you to make some return on your money.
After an entire decade of savers and emergency account owners being punished with low yields and few good options, solid yields have returned. Charles Schwab’s money market currently pays 4.61% APY; many standard bank savings accounts are 3%-4%.
Going back to the 3-6 months expenses, if your monthly expenses are $3,333 a month, then putting $10,000 into an account that takes no risk in the market yet still pays some return makes sense. If you have a stable job and do not mind some risk, invest half of your emergency account into an ETF with some stock exposure and more upside. If you have a less stable income or are more conservative or tend to worry, then sticking to a money market, I-bonds, or some bond mutual funds that are low to intermediate duration and relatively low risk would make some sense that you are less likely to have to access and have the potential to get a 4%-7% return on. Some shorter-term bank notes are also appropriate for that last month or two of expenses in your emergency account.
Some treat precious metals, antiques, or collectibles as quasi-emergency funds. However, this is not a good idea because those items can be pretty volatile and are usually somewhat illiquid.
When do I use this fund?
The answer may seem obvious…an emergency, but what decides “an emergency”? As human nature, we tend to rationalize and confuse ourselves as to what is an “emergency” warranted to use the money in this fund.
Dave Ramsey recommends asking three main questions as a safeguard from utilizing our emergency funds too often.
Is it unexpected?
Is it necessary?
Is it urgent?
Our team of financial coaches tells you to ask yourself, “Is this a ‘break the glass’ kind of moment.” Meaning there are no other options or no more flexibility in your monthly budget to come up with the money needed.
A car accident is unexpected; going over your Christmas shopping budget is not. Having reliable transportation to and from your job is necessary. Upgrading the model, look, or feel of anything you currently have, which is working fine, is unnecessary. Fixing your furnace at the beginning of winter is urgent, but buying something unnecessary because it is “on-sale” is not urgent.
Creating the behavior
In summary, like many financial planning matters, an effective strategy with an Emergency Fund is 20% knowledge and 80% behavior. Once you understand the basics and establish a low-risk and liquid account, having the discipline to access your emergency fund only when an unexpected true emergency happens is the formula for success. Then after those funds are spent on that necessity, having the discipline to replace those funds is vital because life happens, and none of us will have only one emergency in our adult life. As always, we recommend you speak to your Whitaker-Myers Financial Advisor or contact our financial coach team to establish and maintain a good emergency fund and a disciplined and sensible strategy.
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