How much should I save in an emergency fund?Submitted by Castlebar Asset Management on September 17th, 2013
One of the first financial questions I ask prospective and existing clients is where do they stand with their short-term savings or an emergency fund. The responses are usually all over the map. Some folks have years with of income saved up while others have high net worth but virtually no savings. Emergency funds are one of the building blocks of financial planning. If you don’t have an emergency fund and the unexpected happens than it can create havoc in your financial life.
Why should you have an emergency fund?
A short-term savings fund or emergency fund is there to help cushion the unexpected events in life like losing your job, experiencing health issues or unplanned household expenses. Having an emergency fund in place will reduce some stress in a situation when you’ll likely need to be focused on something other than money. It will also prevent you from using your credit cards to pay for living expenses or evening tapping tax deferred retirement accounts. Both of these can be expensive in their own ways.
How much should you have in an emergency fund?
I recommend that you should have between 3 and 6 months of expenses in your emergency fund. This is generally the consensus among financial professionals. If you are in a job that is very stable, you can hold closer to 3 months of expenses. For people in careers that are in more volatile industries it would be wise to have 6 months or even more in savings for emergencies. In general, most people are way too optimistic when it comes to their job security. It is better to be more on the cautious side. Having 3 to 6 months in emergency savings is agnostic to your income level.
What should I use this account for?
Emergency funds should be used in case of unexpected events only. We discussed losing your job and other cases above. If your air conditioner goes out in the summer or your car needs an unforeseen repair this would be an acceptable use of this fund. You will need to top off the account to build it back up to its prior level over the next several months. Your emergency fund should not be used for vacations, to renovate your master bathroom or cover a budget shortfall. These are expenses that should come from your household budget.
Next week I will talk about what you should hold in your emergency fund.
Disclaimer: 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 which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.