Building Up Your Emergency Savings Fund
Why do you need funds for an emergency? How much do you need?
These are good questions. Luckily, the answers should encourage you to take steps to prepare for the unexpected.
The Wake-Up Call
In the wake of the recent U.S. government shutdown, Americans were reminded that having an emergency savings fund is better than the alternative. Many folks have less than six months of savings set aside for a financial emergency.
According to the January 2019 Prudential survey, “Financial Fragility: How the Shutdown Affected the Household Finances of Federal Workers,” many federal government workers were significantly affected by the shutdown. The survey found that 49% were not able to pay bills on time, 42% had to use a credit card or take out a loan and 35% decreased or used all of their emergency savings.1
In addition, 27% of the furloughed or unpaid federal workers or contractors and spouses surveyed by Prudential did not pay their mortgage or rent payment while 26% reported they borrowed money or withdrew it from a retirement account.2
A Bankrate survey found that 29% of people surveyed had enough savings to cover six months or more without monthly income.3 A short loss of income can have a big impact on our finances.
Saving Now Can Make a Big Difference Later
Financial planners typically advise people to have between six and 12 months of funds saved and accessible on short notice for an emergency. Consider monthly costs for rent or mortgage, food, gas, car, insurance, health care and credit card payments. Multiply that total by the number of months. Unfortunately, mutual funds, CDs, stocks, bonds and other investments intended for long-term goals don’t qualify as good resources. They lack liquidity, have potential for loss and will likely disrupt other financial goals.
Checking, savings and money market accounts serve as a safe and ready source of funds in the event of an emergency. They help cover costs and avoid the pain of selling dear investments or scrambling to meet obligations. Family, friends, credit cards and 401(k) loans are sources of last resort in a financial crisis.
Inspired to Plan Ahead
The government shutdown raised general awareness about the benefits of having rainy-day funds. Prudential’s survey also found that “34% of the general population said they plan to add to their existing emergency savings funds, and 11% who have no fund said they plan to start one.”4
It may be easy to put off planning on sunny days, but such days represent some of the best times to make emergency fund plans. It is much better to be prepared when clouds and storms arrive and financial surprises happen!
Emergency Savings Q&A
1. Some sources recommend 3–6 months of savings while some suggest 6–12 months. How much makes sense to save?
Set a goal of three months of savings. After reaching that mark, I encourage people to set a new goal of six months of emergency savings. By setting realistic goals, it is easier to achieve them. For most people, accumulating 6–9 months of emergency funds should provide a sense of comfort and satisfaction.
2. Why do I need an emergency fund if I can use a credit card for emergencies?
Individuals who tap or max their credit cards in an emergency may then only pay the monthly minimums. The interest rates (non-deductible) charged on unpaid credit card balances are among the highest rates charged anywhere. Typical rates can range anywhere from 14% to 25%. Using a credit card for living expenses during an emergency quickly shrinks the available credit on that card and could impact credit scores. A mound of compounding credit card debt is among the most difficult debt to pay off. It is better to plan ahead and save money to avoid using this resource.
3. What financial situations would warrant using some of the savings in an emergency fund?
Most couples rely on both incomes. The job loss by one partner or spouse may trigger a financial emergency. An unexpected home repair, car trouble or sudden family health crisis can trigger an emergency.
When I unexpectedly lost my job several years ago, my wife called me that same day to say her car stalled in the middle of traffic. The transmission repair was a shocking $3,000! Thankfully, we had emergency funds to cover those expenses.
4. If we are already saving in a savings/checking/money market account, should we have a separate account for an emergency fund?
As an example, accountants often recommend that individuals establish a separate account just for taxes. This tactic works very well for them. In the same way, I suggest having a separate account earmarked for or formally titled as emergency savings. Imagine this account is encased in glass. Break the glass only in case of an emergency!
SOURCES
- “Financial Fragility: How the Shutdown Affected the Household Finances of Federal Workers.” Prudential Insurance Company of America, 2019.
- Ibid.
- Taylor Tepper, “Most Americans Have Inadequate Savings, But They Aren’t Sweating It.” Bankrate, June 20, 2018.
- “Financial Fragility: How the Shutdown Affected the Household Finances of Federal Workers.”
