Your emergency fund is a reserve for any unexpected event in life that may happen and impact you financially.
What are unexpected events? Unexpected events include (but are not limited to):
Damage to your home and belongings due to Mother Nature (hurricane, earthquake), an accident (fire, fender-bender) or unforeseen maintenance (hot water heater leak);
Medical diagnosis for you or a loved one (cancer, Alzheimer’s, assisted living); or
Loss of a job (as of November 2011, unemployment rate in the U.S. was 8.6 ).
While insurance may cover some expenses associated with an unexpected event, you may need to wait for reimbursement. How will you pay for these expenses during the interim? That’s where an emergency fund is important.
It’s been recommended to have at least 3 months of expenses for dual-income households and 6 months of expenses for single-income households. Given today’s economy, job loss is a reality for many people. How many people do you know found a job in 6 months? Times are different and having 3- to 6-months of expenses in your emergency fund may not be enough if you no longer have a job. It may be realistic to target 9 months of expenses for dual-income households and 12 months of expenses for single income households.
To calculate how much to save in your emergency fund, first identify all expenses you would still have if you lost your job. Some expenses may be less than you currently spend (for example, your gas cost may go down but you still need to drive). Make sure to include expenses that you pay once or twice a year. Here are some expenses to consider:
Housing (rent/mortgage, HOA fees, insurance, utilities, taxes)
Car (payment, gas, insurance, ad valorem tax, maintenance)
Personal care (dry cleaning, clothing, personal grooming items),
Food (groceries, dining out)
Medical (COBRA, insurance, co-pay)
Pet (food, annual vaccinations)
As an example, let’s look at Stacey’s situation. She is single and calculates her expenses to be $10,500 per month. She re-examines this amount to identify if she can further reduce expenses if she lost her job. She identified a way to reduce her expenses to $10,000 per month.
For an average emergency fund, she would need $60,000 (10,000 * 6). For a solid emergency fund, she would need $120,000 ($10,000 * 12). Since the thought of moving back in with her parents is extremely unappealing, she determines she needs a solid emergency fund with 12 months of expenses saved.
Right now, she has $0 in her emergency fund. So after she freaks out about the number, she follows these steps to create an action plan.
Step 1: She breaks her goal down into three target amounts:
Target A: $40,000
Target B: $80,000
Target C: $120,000
She will initially focus on Target A and gradually move to Target C.
Step 2: For birthday and holiday gifts, she asks for money to apply to her emergency fund. She dedicates her year-end bonus to this fund. And, any increase in salary, she would apply the difference to this fund until she reaches her goal of $120,000.
Step 3: She calculates how much she can save a month toward this goal. She estimates $2,000 per month. In a year, she would have $24,000. At this rate, she would reach Target A in less than 2 years, Target B in over 3 years and Target C in 5 years. Not an ideal scenario for Stacey – 5 years is too long for her to stay focused on this goal.
She decides to re-examine her monthly expenses and see what else she could reduce temporarily until she saves a solid emergency fund of $120,000. She estimates she could save $4,000 per month. In a year, she would have $48,000. At this rate, she would reach Target A in 10 months, Target B in less than 2 years and Target C in 2.5 years. For Stacey, these goals are more achievable.
Step 4: She tracks how she is doing (comparing her actual savings with her target) every 3 months (or quarterly). She will adjust based on if her expenses increase/decrease and if her income increases/decreases.
It’s human nature to procrastinate. Many people think that they’ll “cross that bridge when they get there” – but what if you don’t have the resources to cover emergency expenses? Do you want to burden your family with your lack of financial planning?
If you need help establishing an emergency fund, please contact us. We’ll work with you to determine the amount you should save and how you can adjust your spending to start saving for your emergency fund.
ABOUT THE AUTHOR:
Niv Persaud, CFP®, CDFA™, CRPC®, is the Founder of Transition Planning & Guidance, LLC. Her firm bridges the gap between financial planning and coaching. As a Transition Consultant, she offers sage advice in all aspects of life – financial, personal and professional. Niv does not manage money and does not sell financial products. Her services include spending plan development, divorce financial review, life strategy and professional progression. Niv actively gives back to her community through her volunteer efforts. She believes in living life to the fullest by cherishing friendships, enjoying the beauty of nature and laughing often — even at herself. Her favorite quote is by Erma Bombeck, “When I stand before God at the end of my life, I would hope that I would not have a single bit of talent left and could say ‘I used everything you gave me’.”