By Michael Kennedy, CFP®
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.
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.
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
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
Inspired to Plan Ahead
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
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!
sources recommend 3–6 months of savings while some suggest 6–12 months. How
much makes sense to save?
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.
do I need an emergency fund if I can use a credit card for emergencies?
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.
financial situations would warrant using some of the savings in an emergency
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.
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.
we are already saving in a savings/checking/money market account, should we
have a separate account for an emergency fund?
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!