Wondering if you need an emergency savings fund? The short answer for most of us is yes. Have you seen the statistic—that the majority of Americans wouldn’t be able to manage an unexpected $400 car repair? The odds are that you do need an emergency fund to be able to navigate life’s curve balls and still sleep at night.
How much do I need?
Your emergency stash should cover those unexpected car or home repairs, medical bills and other expenses you couldn’t predict. But one of the most important functions of this financial buffer is to cover a loss of income. To be effective, you should target saving:
· 3 months of living expenses if you have a two-income household, or
· 6 months of living expenses if you have a one-income household
Few of us plan to lose our jobs, whether for economic, performance, or health reasons…or just due to bad luck. Nor do we expect that it would take long to replace our employment income, if we needed to. Having worked with long-term unemployed professionals during the last recession in North Carolina, I can tell you that these folks didn’t anticipate their misfortunes either! Several months of living expenses in savings reduces stress while you get life sorted out.
Saving several months of living expenses may seem daunting, but you can build up to it over time. The best way to start is by making it automatic. Have a set amount transferred to savings when your pay arrives. Most of us don’t even realize the money is gone. Even if you’re paying off credit cards or student loans, set aside a fixed amount each pay period for your emergency savings and make it automatic. Those of us born without the saving gene have an amazing ability to spend all that we take in. So don’t wait until you’ve paid for everything else to save because there won’t be anything left.
Where should I keep my emergency savings?
Your emergency funds need to be:
· Accessible: easy enough to get to in an emergency but not easy to dip in to for everyday expenses, and
· Free from market risk: money saved for emergencies needs to hold its value and not be subject to the ups and downs of the market.
To meet these requirements, your emergency fund should be in a separate account designed for savings:
· Regular savings, offered by banks and credit unions
· High-yield savings, offered by online banks
· Money-markets, offered by banks, mutual fund and investment companies
These account types will earn a modest return while keeping your money available when you need it. It is critical to keep expenses low so they don’t wipe out your already small return. Keep an eye on the expense ratios when comparing money-market funds!
A Roth IRA, if you’re eligible to contribute to one, can be a great place to keep your emergency fund. Unlike traditional IRAs, there are no penalties or taxes due if you withdraw your contributions from a Roth IRA, just make sure not to take out any of the earnings. And you won’t have to pay income taxes on what you do earn on your Roth. Remember, though, if you are using a Roth to save for emergencies, your investments should be in savings or money market accounts that meet the criteria above.
Can Emergency Savings be invested to earn more?
In a word—no. Stock or even bond investments can be expected to earn more over time than the savings accounts recommended for emergency funds. But the key is “over time”. By investing your emergency fund, you are exposed to market volatility. Your account balance is constantly changing and not always in an upward trend. There’s no peace of mind when you lose your job at the same time the market is down and your emergency fund has taken a 40% hit! We give up the possible upside on this particular pot of money in return for a stable balance that’ll be there when we need it.
Emergency savings boost confidence and provide peace of mind. Get started today!
More questions about your money? Call us at (336) 701-2612.