Emergency Fund

Emergency Fund
By Gary Parsons
Sometimes getting by month to month is hard enough, and stashing away money into an emergency fund is all but an afterthought. Unfortunately, it is the relatively small, unexpected costs that can cascade into a cycle of indebtedness and stress. Accordingly, I believe it is essential to view the emergency fund as a necessity, not a luxury.
An emergency fund can be thought of in two stages. First, can I handle a relatively small expense that is outside of my normal monthly bills and/or budget? Second, can I handle the loss of income for a prolonged period of time?
Consider that, according to a June 2016 Bankrate Financial Security Index survey, 28% of people surveyed had no savings at all. Another 18% had some savings but less than three months.
The lack of buffer for the former group could make simple realities like a broken washing machine, car repair or refrigerator repair untenable. When you are living that close to the edge fiscally, you are rolling the dice on Murphy’s Law. This is not a good position in which to find yourself. Even if it’s only twenty dollars at a time, you need to begin saving for these events immediately.
While insurance is available for large and rare events, the $500 to $1,000 events are too common and for too little money for insurance to efficiently facilitate. As such, you need to be prepared to bear that burden out of pocket.
The second stage involves the standard emergency fund savings and a good rule of thumb is a minimum of three to six months. When I say three to six months, I mean expenses not income. A substantial portion of your income may be considered discretionary and can go away in the event of, for example, a job loss.
In setting this amount, you need to isolate your essential expenses like housing, food, medication, utilities, etc. Things like cable, though you may be quite partial to it, can easily be cast aside in a pinch. The ability to continue making those essential payments for up to three to six months is a sign of financial security.
How you save and invest is up to you. Since cash is a non-earning asset and access to credit is a perfectly acceptable contingency plan in the interim, you needn’t feel compelled to leave a pile of money sitting in a checking account; however, you shouldn’t have it locked up in long-term illiquid investments.
Your emergency fund needs to maintain a level of liquidity such that a small unforeseen event doesn’t snowball on a credit card for years because you either didn’t have the savings or weren’t able to get convert it into cash in a reasonable time.
While retirement savings is the end game, don’t forget about the importance of building or replenishing an emergency fund.
This article is meant to be general in nature and is not intended, and should not be construed as personal financial advice. Investing involves risk and the potential to lose principal. Please consult your financial advisor prior to making financial decisions. Gary Parsons is a Financial Advisor with Waddell & Reed and can be reached at 850.894.9950. Waddell & Reed, Inc., Member SIPC (08/16)