The “Why” Behind Emergency Funds
Cash is often a divisive topic in the finance space. People can’t agree on what’s too much, too little, or just right. While cash may not be the highest-growth asset in your portfolio, it still serves a significant purpose. The best example is an emergency fund. Let’s dive into what an emergency fund is, why it’s helpful, how you can set it up, and who should have one.
What’s An Emergency Fund?
An emergency fund is a cash cushion that protects you when you fall down financially. It can help you navigate various situations that are difficult to anticipate but inevitably happen to even the most prepared families.
Typically, it’s recommended that you save 3-6 months’ worth of living expenses in your emergency fund. However, having a larger emergency fund may be helpful for high-earners, those close to retirement, or those with high-volatility jobs. Having up to a year’s worth of expenses set aside can make a big difference in your financial life and free you from the stress of unexpected expenses or decisions.
Your emergency fund should be stored in a highly liquid account such as a high-yield savings account or money market account. The goal is to be able to access the cash quickly and easily if it’s needed.
Why Is an Emergency Fund Helpful?
An emergency fund can serve many purposes, and is ideally an “untouchable” lump sum of cash that you don’t tap into unless it’s (you guessed it) an emergency. Here’s why they’re helpful to have:
Everyone Faces Emergency Situations
Whether you have an extra $100 set aside for emergencies or an entire year’s worth of expenses in an emergency fund – you’ll need to use it at some point. Per the 21st Annual TCRS Retirement Survey, the median emergency fund balance is $5,000 among currently employed Americans.
While this is a fantastic start, the truth is that the COVID-19 era has taught families of every age and income bracket that emergencies happen. Medical bills, unexpected job loss, medical bills, a death in the family, car or house troubles, and more can all be covered by a well-stocked emergency fund.
The truth is that anything could happen, and it’s prudent to prepare for it.
It Can Keep You From Going Into Debt
Have a cash buffer to help you pay unexpected medical bills, cover necessary time off from work, and more. It also allows you to support yourself and your family without going into debt to cover surprise expenses. Many people who don’t have an emergency fund may use a credit card, take out a personal loan, or ask family and friends to help them cover bills. An emergency fund can help to remove a level of financial stress in an already challenging time.
What If You’re a High-Earner?
Many high-income families struggle with the idea of maintaining an emergency fund. They may feel insulated from emergencies because they’re more able to leverage the cash flow they have coming in to weather the storm.
However, high-income families and individuals still need to prioritize an emergency fund. The more money you make, your expenses and cost of living will likely be much higher. If you lose a job unexpectedly or run into a situation where you have a hefty unexpected bill, you may need an even larger emergency fund to make it through a season of financial stress.
In these cases, having up to a year’s worth of living expenses (and lifestyle expenses!) may be wise. If you’re uncertain how much that is, look at your bank and credit card statements. Past spending doesn’t lie – anticipate that many expenses will remain the same, even if you can “recover” from financial strife quickly.
An Emergency Fund Can Help You Reach Your Goals
Finally, the goal of an emergency fund goes beyond simply dulling the impact of a financial emergency. It serves a greater purpose – to keep you on track and moving toward your big-picture financial goals.
With an emergency fund, you won’t have to dip into other accounts or cash flow to pay unexpected bills or cover the loss of a paycheck. For example, if the roof leaks, you won’t be pulling from your 401k or travel fund to cover the expensive repairs.
An emergency fund allows you to continue working toward your other goals while still handling financial hardships in the short term as they come up.
Adrienne Davis CFP®, CPA
All written content is for information purposes only. Opinions expressed herein are solely those of Zenith, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.