The Boy Scouts Motto is “Be Prepared”. You may have a clear understanding of your month-to-month cash flow (income and expenses), but have you considered how you would handle an unexpected expense? These usually sudden, unforeseen events can take many forms:
- Job Loss: The income you had anticipated disappears, but you still have bills to pay.
- Home or Vehicle Repairs: Your roof develops a leak and needs to be replaced, or the transmission in your car suddenly fails.
- Medical Emergency: You develop food poisoning in Yellowstone National Park, and the only medical assistance available is not covered by your insurance. (True story!)
- Death: You need to travel to a funeral, or assist with funeral expenses. Many people do not realize that insurance proceeds are not available right away to assist with the immediate need of funeral and burial costs.
Although you cannot anticipate if or when one of these events may occur, you can “be prepared”. By setting aside money specifically earmarked for these emergencies, you avoid two unpleasant alternatives: utilizing credit cards or accessing assets allocated for retirement or college funding. Credit cards may carry high interest rates and add to any existing debt burden. If forced to access your retirement accounts, such as an IRA or 401(k), you may owe additional taxes, as well as lose the benefit of compounding your investment returns over time.
We recommend setting aside at least three to six months of your living expenses in an emergency fund to cover these events. This is a general rule of thumb and your desired comfort level may have you set aside additional cash. For a one-income household with very little debt and adequate job security, three months may be sufficient. If, however, you have a two-income household with debt payments and one or both jobs lack security, you should set aside at a minimum six months of your living expenses.
It is important to make sure the funds you set aside are not subject to losses and not too easily accessible. If you simply keep the money in your primary checking account, you may be tempted to use these savings for non-emergencies, such as concert tickets, a weekend trip to the beach, etc. The stock market is never recommended for your emergency fund, as it may be subject to losses, and a jar in your backyard is not a good idea for the same reason, unless you keep a detailed map! Money markets, savings accounts, and interest-paying checking accounts are ideal for your emergency fund.
If you do not already have savings set aside, allocate a portion of your budget to building an emergency fund. Hopefully, you will never have to use it, but by “being prepared”, you can rest well at night.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional.