The stock market is at all-time highs and continues to climb, unemployment is low and continues to be at record lows. However, government deficits and consumer debt also continue to rise. Eventually, the economy will enter into a recession, and that might be sooner than later. When that happens an emergency fund could be the difference in your survival.
The first tenet is an emergency fund. Even before you save for retirement that needs to be put in place.Barbara Steinmetz
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What Is an Emergency Fund?
An emergency fund can also be called a rainy day fund or a just-in-case fund. The purpose is for it to retain its purchasing power, be easily accessible, and large enough to support your day to day lifestyle expenditures for a significant period of time.
Emergency funds are chunks of cash set aside for when the metaphorical shit hits the fan. When a recession hits, job loss occurs, and access to capital/credit decreases. An emergency fund ensures that, if hard times hit you, you will be able to stave it off long enough to see the good times return and not be forced into a situation where you need to sell your home or other assets just to keep the lights on.
When Should You Start Your Emergency Fund?
Should you set money aside when you start a family? Once you land a job? When you enter college/university? An emergency fund should be set up as soon as you have financial responsibilities. For some that might be at 16 for others maybe 26.
Regardless of when your financial responsibilities start, an emergency fund is the first place your savings should go. This means before saving for a house, a new car, or retirement.
How Big Should It Be?
The rule of thumb is to have 3-6 months of living expenses saved. However, the size of the emergency fund is dependant on a variety of things; economic outlook, job security, family situation, financial habits, etc.
Economists continue to be mixed on whether good or bad times lay ahead. In our view, is it better to be prepared for the worst and have nothing bad happen, than, prepare for the best and be caught in a pinch when things don’t go as planned. That being said, since things could deteriorate quite quickly, and having 6-12 months of expenses is probably more prudent.
If you have a very secure job where you know that you will continue to make an income even during a recession, 6 months is probably plenty. However, if you think there is a chance of job loss, bigger is definitely better.
Maybe you’re a single person living well within your means. Even if tough times hit, you may be able to cut your spending more, and you don’t foresee any large expenses in the future. If that is you, a somewhat smaller emergency fund might be adequate.
However, what about the family with multiple young children? Unexpected expenses can be more common, and generally, spending is already significantly higher. In this situation, a larger emergency fund is required.
Where Should You Keep It?
Emergency funds should be kept in cash or near-cash equivalents. Does that mean you should shove $15k under your mattress? Absolutely not!
Just because it says cash, doesn’t mean all of it has to be in physical dollar bills. You could keep it in a high-interest savings account at the bank. What about near-cash equivalents? This means things that are highly liquid and do not go down in value. This could be treasury bills, government bonds, commercial papers, high stable and liquid securities, or money-market funds. Essentially anything that can be sold for physical dollars on short notice and doesn’t fluctuate in value.
Regardless of what lies ahead on the economic landscape in 2020, make sure you have an emergency fund. It is prudent to ensure you have, at minimum, 3-6 months of living expenses saved and easily accessible. Even if you haven’t started saving for retirement, an emergency fund should be your first priority.
If you have any questions about where you should be saving your money, or how much you should be saving, reach out to us! We would love to get to know you and help you develop a plan to achieve your financial and life goals.
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy