Given the state of the economy, as well as people’s propensity to spend rather than save having an emergency fund is necessary now, more than ever. I’m sure everyone thinks that job lay-offs, unforeseen medical or automobile expenses, or even natural disasters are problems for the next person to worry about, but then again that’s why it’s called an “emergency fund” and not the “Christmas account” or “summer vacation to Disney account”. Be advised, each person’s individual circumstances will determine how much attention this should get. This is not a “one size fits all” solution. And, before you roll your eyes and say “Oh boy, yet another article on how much should be in an emergency plan” or “Holy crap, how many times can people write about where to put their emergency savings”, you can rest assured this is about neither of those topics.
It is always a wise idea, and something I preach (as well as practice) to all of my clients–have a separate account somewhere, anywhere with some reserves, but the amount is relative and varies from person to person. Why you ask? It is quite simple, actually. With the credit industry in disarray, lenders are scrutinizing new home loan and HELOC (Home Equity Line of Credit) applicants more closely. As recently as a few years ago, people’s home values were so inflated that they could use the equity in the homes as emergency funds, should the need arise. Now, however, with the number of loans in default and the decline of sales prices (and in turn appraised values) it is more difficult to secure any type of loan leading to the need for a liquid emergency fund. Combine that with the increase in the number of job cuts, and the increased competition for the few jobs that are being created, as well as the rise in fuel and utility costs, you are left with a difficult situation should you be out of work for an extended period of time, or suffer any other emergency.
Simply put, having an emergency fund is also a sound financial planning strategy. If you take advantage of the higher-yields paid by online divisions of most banks, even though they aren’t anything to write home about, you will also be earning interest on the deposited funds. Look at a fixed rate savings account because the longer you leave the funds untouched, the more interest will compound. Especially when rates start to rise again (please don’t ask me when that will be), the banks will more likely than not follow suit giving you even higher returns on monies that would provide even more relief should you find yourself in an emergency situation. Another related issue that not many people consider is your credit profile. With a few months of emergency savings, you will be able to continue to pay the mortgage, credit cards, car loan, utilities, etc. which will prevent you from having an accumulation of late notices, or even collections. That in turn will help maintain your credit score which will most certainly come in handy down the road, and is just another added benefit to having a well-funded emergency fund for those who don’t really care about their credit report.
Some people would ask why not just use the money from existing accounts such as savings or investments. To that I say this: because those accounts already have a specific purpose. The emergency fund should be liquid and easily accessible and used exclusively for emergencies, hence the name. A retirement account is used for retirement, a holiday account is used for gifts or vacations, savings accounts are used for storing cash savings. This is also the reason why I state that this account is part of a good financial plan. A complete financial plan covers everything from short-, medium-, and long-term purchases, savings, retirement, other investments, insurances, and yes emergencies. This way, all of your bases will be covered for all facets and stages of life and each of the accounts you have set up will continue to serve that specific purpose exclusively without interruption.
Do what works best for you
I mentioned earlier that the amount of the emergency fund will depend on the person. The reasoning behind that comment is very simple: each person is in a different place in life and has different responsibilities. Someone who is still in college, living at home driving their first car will most likely not have many fixed costs so a relatively small fund should suffice. Conversely, families with children, a mortgage, multiple cars and the associated bills will need to have significantly more money put away.
Everyone needs to analyze their situation to figure out what bills they would need to cover and how much they need to save. There are plenty of articles on the internet with people who profess to have the perfect plan for anyone, but they don’t take into account the differences mentioned above. The authors want to be thought of as “experts” and are too caught up in their own lives to realize that not everyone is in the same position as they are. Sadly, they just don’t consider the fact that not everyone is the same.
I would love to hear from people , but especially those who do not have or believe in the concept of an emergency fund. Why is it that you haven’t set one up yet? If you don’t think they are important, I’m very curious as to why that is.