This month, we are discussing emergency funds. An emergency fund can really help shelter you from financial and life setbacks. An emergency fund, filled to whichever milestone you are able to reach, will help you feel more confident in your ability to handle life’s curveballs.
Highest Deductible
A modest but highly impactful milestone toward a fully funded emergency fund is to save enough to cover your highest deductible. For example, if your car insurance deductible is $1,000, that would be your goal. Raising your deductible can lower your monthly car insurance payments, and if you have an emergency fund saved to the deductible amount, you would have the means to save on your insurance and still cover your deductible in case of an accident. This amount will help build your confidence to meet life’s financial challenges head-on.
3 Months of Bare-Bones Spending
The next emergency fund milestone is three months’ worth of bare-bones expenses. These expenses would include rent/mortgage, essential groceries, electricity, water, and other unavoidable costs, but would not include expenses such as dining out or subscription services. In some situations, a three-month emergency fund may be all you need. For individuals in a dual-income household, a three-month fund may be sufficient, but it should cover three months of your total household essential expenses. Additionally, if you work in a field where you believe you could easily obtain another similarly paid position, a three-month fund may be enough for you.
6 Months of Bare-Bones Spending
There are life situations that could greatly benefit from having an emergency fund of six months of essential expenses. A six-month fund may be well-suited for those with variable income or for single-income households with dependents. Having an emergency fund that covers six months of expenses can give you a high degree of security. In the case of a job loss, a six-month fund can give you the confidence to find a job that truly matches your values and professional goals. You will also be well-prepared for large expenses such as medical bills, vehicle repairs, or home repairs.
12 Months of Spending
For those in early retirement, there are scenarios where having a 12-month savings reserve may be a good idea. If a person is funding expenses from portfolio withdrawals, they may face what is called sequence-of-returns risk. During the first few years of retirement, a bear market with negative growth means withdrawals compounded by losses could deplete a retirement nest egg much faster than expected, leaving later years with limited funds. In this scenario, it could be smart to ride out that period using liquid funds saved in a 12-month reserve. Additionally, this would no longer be a bare-bones budget, since most people enjoying retirement do not want to be constrained to bare-bones spending.
You Can Do It
Working toward funding an emergency account of any amount can feel overwhelming. Set a deadline for funding your emergency fund and then break it down into monthly contributions. Things will come up and set you back, but the important thing is to jump right back in afterward. The peace of mind that comes with a funded emergency account is worth more than the dollar amount. You can do it!
If you have any questions related to personal finance, or suggestions for topics you would like this column to explore, feel free to email me at masonmoneysolutions@gmail.com.
Currently Reading: “Happy Go Money: Spend Smart, Save Right & Enjoy Life” by Melissa Leong
Andrew Mason, MBA, AFC Candidate
Disclaimer: This column is for educational purposes only and does not constitute financial advice.