So, in this post I mentioned emergency funds, and I’ve been meaning to write a separate post about them. That’s because everyone – or at least every household – should have one.
That is scary. I mean, it seriously worries me for the sake of all the people out there who fall into this demographic. Emergency funds aren’t about reaching financial independence. FI is something you pursue well after you’ve secured your emergency fund.
Think of FI like a sort of graduation: for many, it is the culmination – the finish line of a long financial journey. But much like graduation, no one reaches FI without many small accomplishments preceding it. The emergency fund, then, is just the first of those accomplishments.
What will you do when Emergencies happen?
Imagine this: things have been going pretty well at your job. You’ve been getting a lot of positive feedback from customers and teammates alike, and think you might be getting a promotion pretty soon!
Then one day you go into work, find our your company has been bought out, and you are losing your job.
Yes, I know, you probably don’t want to think about it.
But this is actually a sort of theory I have. I’m no psychologist, but I believe most people don’t even want to think about what would happen if they lost their job. So they don’t think about it.
Because they don’t want to think about it, they don’t think about it. And because they don’t think about it, they don’t prepare.
But it’s imperative that you are prepared. You simply never know what tomorrow will bring. That isn’t to say that you have to have $50,000 in cash waiting at a moment’s notice, but you certainly have to have something.
How much should you have saved?
This is a question that almost always enters the discussion about emergency funds. I’m going to posit two reasons for this:
- First and foremost, of course you need to know how much you should have saved. After all, having one week of savings would certainly not be enough.
- Piggybacking on #1, I also believe everyone asks this question because there is no definite answer. Think of it like pondering the meaning of life: if the answer were obvious, there would be no reason to keep asking the question over and over.
Okay, so even though I couldn’t possibly tell you exactly how much you should have saved, I can certainly give you my thoughts on the matter.
The link at the beginning of this post about Americans having less than $1,000 saved has a video of Suze Orman giving her recommendations around emergency savings. Suze says that while people typically recommend 3-6 months of sayings, you should have 8 months of expenses covered.
She cited the 2008 financial crisis as the reason for this; if we have a repeat of 2008, 3-6 months may be cutting it too close.
10 years later, we haven’t yet had another 2008. But she has a point: it could happen at any time, without notice. That being said, I do agree that if you can manage to cover 8 months of expenses, you are probably in a good place.
Emergency funds: the easy way
I am mostly mentioning this to illustrate a point; I do not necessarily recommend that others do this.
In most cases, people will keep their emergency funds somewhere that is highly liquid, such as their checking or savings account. In a lot of ways, this makes sense, since you will have access to the cash very quickly.
The biggest drawback to this approach: these accounts will earn you little to no interest, which means that they will likely lose value over time due to inflation.
Not only that, but here’s the kicker: once you have enough saved, it would be wise to start putting money into an investment, or something that will actually grow in value. That means there is a certain cutoff point where you stop putting money into that liquid account.
That cutoff point is the reason people are always asking how much they should have in emergency savings.
But that’s now how I do it.
Instead of having a separate account for emergencies, I keep very little cash on hand and invest the rest. Here are the reasons I do this:
- Almost all of my money is earning a return. ‘Nuff said.
- Most emergency expenses, such as medical bills, can be covered with credit. If need be, I can charge those expenses and sell off some of my invested cash.
- I tend to think that if there is an investment catastrophe, such as a stock market crash, that I will have much bigger worries than how much cash I have on hand.
- And, most importantly: choosing not to separate my emergency savings from my investments means I eliminate that cutoff point. In other words, I am always saving more and more. I could potentially use some of those savings for a trip or something, but I would never dip into my emergency level savings. This bold part is why I don’t recommend this strategy to others. I’m not saying I am “better” than anyone; I just know that financial restraint is one of my strengths!
What is your saving strategy?
I realize that my strategy would probably not be the best for everyone. In fact, I may even get burned by it. If I do, that will be my own fault, and that is why I’m hesitant to recommend it.
But I’m curious as to how others structure their emergency savings. Do you have a better way? I would love to hear your thoughts on this topic.