Is It Time to Rethink the Emergency Fund?

For the longest time in wealth management the recommended amount of money to have in an emergency fund has been three to six months of non-discretionary expenses (mortgage, rent, utilities, groceries).

Typically, three months was the recommendation for a single individual or married couple with dual incomes. Six months was generally for married couples with one income earner.

Every so often, something comes along challenging conventional wisdom, and that can be a good thing. In this case, it’s a pandemic that’s changing how we think – about many things.

The pandemic has wreaked havoc on many lives. People have been laid off, lost jobs, are working less hours, losing income. Those with emergency funds have seen them dry up, and those that didn’t have them to begin with were worse off.

For the future, it may be wise to consider a longer (more money) emergency fund. For example, we can consider an emergency fund of nine to twelve months, perhaps longer. In fact, many retired individuals have emergency funds of twelve to twenty-four months.

Granted, retired individuals are using their emergency funds to wait out market volatility, but in a sense, working individuals are using their funds to wait out employment and income volatility.

In both situations, the longer the emergency fund the less likely individuals will have to dip into their retirement savings either when markets are down (retired individuals), when saving for retirement (working individuals), or both.

To calculate how much you need, simply look at all your non-discretionary expenses, add them together, and multiply by 9, 12, 24, etc. The reason I say non-discretionary expenses is because we can cancel TV services, subscriptions, stop dining out, etc. in an emergency.

Once you’ve got the amount you’ll need, start saving. It may take some time, but a good goal would be to save a month’s worth at a time – thus in nine months, you’d have a 9-month emergency fund and so on.

Finally, put your emergency funds in a safe place such as an FDIC insured savings account. Don’t keep them in a safe at home (most insurance companies will not reimburse you if it lost, stolen, or destroyed), and don’t put it in risky assets such as stocks, bonds, real estate, etc.

You want easy access to this money, without worrying that when an emergency arrives, your funds have dropped from volatility.

 


Originally posted at https://financialducksinarow.com/14177/is-it-time-to-rethink-the-emergency-fund/

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