How Much to Save for Emergencies from a Financial Advisor

In March 2023, the abrupt closure of several banks caused significant upheaval in the banking sector and the stock market. This event came on the heels of prolonged tech industry layoffs, high inflation, and increasing interest rates. The future remains uncertain, and it's unclear what might happen next.

This situation highlights the importance of preparing for the unexpected. An emergency fund is important for unexpected events like losing a job or emergencies not covered by insurance. By building up your emergency savings, you can safeguard your financial well-being and that of your loved ones. Additionally, earning a return on your savings can help maintain your future purchasing power.

Here are answers to five common questions about emergency savings, like how much to save and where to keep the money.

How Much Should You Save for an Emergency?

Many financial professionals recommend having $1,000 in savings to cover basic expenses and protect against financial setbacks like job loss.

If you're single but have family support, having savings to cover three months of expenses might suffice. However, if you have a spouse, children, and a mortgage, or if you're concerned about quickly finding new employment, aiming for six months or more in savings might give you greater peace of mind.

If you become unemployed, various resources can help mitigate the financial strain.

Where Should I Keep My Emergency Savings?

It's smart to keep your emergency savings easily accessible and avoid risky investments that could lead to losses. Separating your emergency fund from your regular spending money and other types of savings can help prevent unnecessary withdrawals.

Here are some options to consider:

• Savings or Money Market Accounts: These can be convenient and accessible. Savings accounts typically offer modest yields, often below 0.15%. Money market accounts, offered by banks and credit unions, may provide slightly higher yields but often require a higher minimum balance and may limit withdrawals (e.g., unlimited ATM withdrawals but restricted checks and debit card purchases).

• Money Market Funds: These are generally lower-risk and can offer better rates than standard savings accounts. However, unlike savings accounts, they are not FDIC-insured.

• Treasury and Government Money Market Funds: Designed to maintain a stable net asset value (NAV) of $1.00, these funds do not restrict your ability to access your money.

• Certificates of Deposit (CDs): CDs might offer higher rates than money market funds but usually penalize early withdrawals. Consider using short-term CDs for some emergency savings but avoid locking up all your funds in them. Be cautious with your money.

When deciding where to keep your emergency savings, consider withdrawing from more liquid accounts first, such as a savings account, which allows same-day access without penalties. Money market funds may not allow instant access. You may need to sell the fund and wait until the next business day to get your cash.

To avoid losses from taxes, penalties, or market volatility, try to avoid withdrawing from retirement accounts like a 401(k) or IRA before retirement age, as this could result in taxes and a 10% early withdrawal penalty.

What About Borrowing to Cover an Emergency?

In some situations, borrowing to handle an emergency might be necessary if you lack other financial reserves. Options include a home equity loan or line of credit, as well as credit cards. However, it's crucial to weigh the potential consequences of borrowing against your home, including financial, legal, tax, and estate implications. Defaulting on such a loan could even result in losing your home.

Here are four important considerations:

1. Income Loss: Borrowing money, especially at high interest rates, can be risky if you've lost income. Debt can quickly accumulate if you're unable to pay it off promptly.

2. Existing Debt: If you already have significant debt, relying on credit or loans during an emergency can exacerbate your financial situation, making it harder to recover.

3. Credit Availability: During a global economic downturn, credit may be less accessible. Lenders might tighten lines of credit, so borrowing might not always be a reliable option.

4. Interest Rates: If you do need to borrow, aim to secure the lowest possible interest rates to minimize the cost of borrowing.

How Can I Save More for an Emergency Fund?

Even on a tight budget, there are a few strategies to boost your emergency savings:

1. Treat Your Emergency Savings Like a Bill: Just as you prioritize rent, mortgage payments, and retirement contributions, make saving for emergencies a monthly priority. By treating it as a non-negotiable expense, you'll develop the habit of regular contributions.

2. Trim Spending: Look for areas in your budget where you can cut back, even if only temporarily. Redirecting these savings into your emergency fund can help you build it up more quickly.

Can Insurance Help Protect Me in an Emergency?

In addition to having accessible cash, insurance is another vital component of emergency preparedness. Adequate insurance coverage can reduce the amount you need to draw from your emergency savings when unexpected expenses arise.

Consider these types of insurance:

1. Disability Insurance: Whether provided by your employer or purchased independently, ensure you have sufficient coverage in case of disability.

2. Health Insurance: Losing your job may also mean losing employer-provided health insurance. While COBRA allows for continuation of coverage, premiums can be significantly higher—up to four times more than what you paid as an employee. Plan for potential health care costs by setting aside extra funds to cover these expenses.

The Bottom Line

Everyone needs an emergency fund, regardless of age or income level. The recent pandemic has underscored this need, but many other situations can also demand immediate cash access, such as job loss, natural disasters, home repairs, unexpected childcare expenses, surprise medical bills not covered by insurance, or helping family members in need.

Planning ahead is crucial. By consistently saving for emergencies in liquid accounts, supplementing your savings with adequate insurance coverage, and keeping some low-interest credit options available as a last resort, you can be better prepared for life's unexpected challenges. This preparedness can provide significant peace of mind.

Sources:

https://www.fidelity.com/viewpoints/personal-finance/save-for-an-emergency

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.