Even if you and your family weathered the crises of the past couple years, you probably know people who have not fared as well. Health problems, business shutdowns, lost jobs and inflation have all exerted extreme financial pressure on Americans, but an emergency savings fund has kept some people afloat.
A stash of cash can help if you lose your job, experience health problems or face emergency home repairs and other unexpected expenses. However, you need to make sure that you are saving enough, given your income and lifestyle.
Cover nondiscretionary expenses
You may have heard that you need cash savings of three to six months of living costs, but this rule is not as straightforward as it may sound. Some experts say that you need to save enough to cover three to six months of expenses, but others believe you should save three to six months of take-home pay. Depending on your family’s financial and other circumstances, you may need to save an amount at the lower end or aim for the six-month target.
Emergency fund savings targets often are expressed in terms of take-home pay, but most people are better off focusing on expenses, particularly nondiscretionary expenses. During a temporary emergency, you can always eliminate spending such as vacations, entertainment, dining out and nonessential shopping. Your emergency fund really needs to cover mortgage and property taxes or rent, utility, phone and Internet bills, car payments, food, health care, insurance and credit card or other debt payments.
Focus on your target
Determine the target size of your emergency fund by totaling nondiscretionary expenses over the time period that you anticipate it would take to find a new job or cover another emergency. Be sure to subtract other income sources, such as a spouse’s salary or rental property income.
Keep in mind that reasonably foreseeable expenses are not emergencies and should be saved for separately. For example, you may expect that you will need to replace your roof in two years. Or you may be planning an elective medical procedure or a family celebration in the near future. Do not dip into emergency funds for these planned events.
At the same time, try not to save too much. If you save substantially more than you will reasonably need in a low-interest savings account, you may actually lose money to inflation over time. Plus, you might miss out on opportunities to invest those funds in tax-advantaged retirement accounts or in other assets.
Take immediate action
If you do not have an emergency fund, you are not alone. According to the Consumer Financial Protection Bureau, 24% of Americans have no emergency savings, 39% have less than a month’s worth of expenses saved and 37% have more than a month’s worth. If you land in one of the groups that would be forced to turn to credit cards, subprime loans or other undesirable methods to finance an emergency, start building your cash cushion immediately.
You might arrange for a portion of every paycheck to be deposited automatically in a savings account. Also consider reducing certain expenses, such as entertainment subscriptions and restaurant meals. You may also adjust your tax withholdings, so you receive more currently instead of a tax refund when you file your annual return.
A secondary issue
People who do not have adequate savings usually suffer from another issue: They lack a household budget. Make a realistic expense plan now and stick to it so you will be able to put money aside for an emergency. If you are having trouble budgeting or finding funds to save, contact your financial advisor.
For more information, contact Azuwa Omietimi or your ORBA advisor at 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.