Do you really need an emergency fund?You are here : Home  »  Finance And InvestmentGuest Post   »   Do you really need an emergency fund?

Categories
Finance And Investment Guest Post

Do you really need an emergency fund?

What is an emergency fund?

Simply put, it is a store of money, typically cash or a cash equivalent like an investment in US Treasury securities, that can be used in case of an emergency and only in an emergency. As financial advisors in northeast Ohio, where not only do we get lots of lake-effect snow in the winter, we see torrents of lake-effect rain in the spring and summer.

Many areas of Cleveland receive so much rain that many rivers and tributaries overflow with runoff. This can cause sewers and drains in people’s basements to backup. Insurance policies don’t typically cover sewer and drain backups unless there is a specific endorsement to do so. Imagine you have a backup and you don’t have this coverage.

I’ve seen where people’s basements will fill nearly 2 feet full of backed up sewer water causing tens of thousands of dollars in damage to carpet, drywall, furniture, appliances, and mementos. If you had to pay for something like this, an emergency fund would be unbelievably helpful.

How much should be in an emergency fund?

I hate to use this term because everyone’s situation is different, but the rule-of-thumb is somewhere between three- and six-months of basic living expenses. If you are single and have no dependents, then 3-months may suffice. If you are married, with children, and the only one working, then you should probably aim for the six-month mark, or even more depending on how many mouths you must feed. Other things can come into play when making the decision too.

You should consider the work you do. If you must dip into your e-fund because of a job loss, how quickly will you be able to find another job?

How can you save an emergency fund?

My instinct is to keep cash in a savings account. They are safe and well protected by the bank’s federal deposit insurance. The only downfall to this is that banks don’t pay well for use of your money. We are living in a time of very low-interest rates and keeping money in a savings account, or even a money market account, for a long period of time can end up hurting your savings due to inflation.

The inflation rate has been fairly steady over the past few decades at around 2-3%, give or take a bit. Savings accounts have earned interest over the past several decades at around 0.5-1%, give or take a bit. This means that you are losing money by saving this way.

If you want a risk-free (in name only) way of storing your money, then a bank account may be the way to go, but by taking on a bit more risk, you could edge up your interest rate to at least keep up with inflation. For e-funds, things like Treasury securities are a low-risk possibility.

I would like to recommend TIPS. These are treasury securities that keep pace with inflation. TIPS stands for Treasury Inflation-Protected Securities. These securities are designed to keep up with inflation so that investors/savers don’t lose the purchasing power of their money.

Another cool thing about TIPS is that if you don’t want to buy a mutual fund or exchange-traded fund that holds them, you can go online and buy them directly from the Treasury Department. You can set up a direct deposit and you can even use your tax refund to purchase them. Simply go to https://www.treasurydirect.gov/ and establish an account.

A few of us have the means to simply put a lump-sum amount into an account for this purpose, so one of the best things to do is to simply start a small monthly, or bi-monthly, deferral – just like you do to your 401(k), and begin saving for that goal. It may take a while, but with persistence, you’ll eventually get there. And someday, you’ll be glad you did.

Do you really need an emergency fund?

My answer is always an unquestionable yes, but I am merely an advisor to my clients, and everyone has to decide that for themselves. It may be that your budget is tight and saving for an emergency fund isn’t something you are able to do now. One last thought about an e-fund, however. It is a lot like an insurance policy.

A policy that you are using to self-insure against occasional or remote occurrences that could leave you financially underwater. You should never drive without liability insurance, you shouldn’t own a home without dwelling insurance, so think of an emergency fund as insurance for the unexpected that you are going to have to pay for yourself because traditional insurance may not.

About

Brent Dickerson, CFP® EA, is the owner of Over Coffee Financial LLC near Cleveland, OH. Brent helps Gen-X professionals who are ready to get serious about their retirement. With a focus on long-term goal attainment, Brent’s clients find focus and clarity towards their goals. Learn more about Over Coffee Financial’s financial planning solutions at www.overcoffeefinancial.com

Leave a Reply

Your email address will not be published. Required fields are marked *

Leave a Reply

Your email address will not be published. Required fields are marked *