Let Me Clarify
Times like these show us that life does not always go as planned and that nobody can predict what events might take place tomorrow. Of course, the COVID pandemic is an outlier, but there is an infinite number of what-ifs that could cause financial stress at any moment. Even during what would be considered more “normal” circumstances, I cannot emphasize enough how important it is to consider an emergency fund.
Let me clarify.
I completely understand that plenty of people live paycheck-to-paycheck and may not be fortunate enough to have excess savings throughout the month. However, statistics show that majority of those with a more positive financial situation still lack a true emergency fund.
Whether you are graduating and beginning your career, knocking on the door of retirement, or have outside investment accounts, there are plenty of reasons that you should plan on building up an appropriate amount.
What is an “emergency fund” and why does it matter?
A true emergency fund is liquid savings that would be immediately accessible in the event of an emergency or other unforeseen need. The idea is that these savings would be able to cover certain unexpected bills without having to use credit cards or any other debt.
According to the Federal Reserve (as of August 2019) the average APR on credit card accounts accruing interest was 16.97%. You can probably imagine how much money could be saved if at least some credit card expenses could be avoided.
Further, it is important for an emergency fund to not be subject to frequent changes in value. This means that an investment account is not the solution. Why not? Well, even if you have an investment account that is accessible without penalties or major fees, consider what has happened in the market so far this year.
Emergencies do not always happen at opportune times. If these savings are in an investment account and “life” happens while the market is down, you are forced to sell while your account is lower and may not even have enough to cover what you need.
How much should I save?
The basic rule of thumb is to plan on having a long-term goal between 3 and 6 months-worth of living expenses. (Note that this is based on monthly expenses and not income.) In that case, if you lost your job, for example, you would have enough savings on hand to cover your expenses for up to 6 months, while you get back on your feet.
Financial planners use the range of 3 to 6 months, since an appropriate amount depends on the individual’s situation. Job security, additional sources of income, and your stage of life all have impacts on the amount you might feel comfortable having on hand.
Also, keep in mind that this amount is a long-term goal. Everybody must start somewhere. Depending on your situation, that may mean setting aside a few hundred dollars or adding $50 per month to an account. Remember, some action is better than no action, and the important part is to set a goal and to make it a priority.
Where should I save it?
To fit the criteria of accessibility and not being tied up in investments, a few of the main options are a general savings account, CDs, money market accounts, and high-yield savings accounts. Of course, these will not make you rich, but they are not meant to. They are meant to provide stability and easy access.
Currently, high-yield savings accounts are increasing in popularity. Depending on the bank, there can be a limit on the amount of transfers per month or minimums to open. But, through decreased overhead for online-only banks and other reasons, current rates can be above 1.5%. Again, not huge, but much more than the traditional checking/savings account. Marcus, Capital One, and Ally are a few examples of those who offer them and www.bankrate.com is a great resource to learn more.
Obviously, this all starts with getting a handle on your overall cash flow situation and having a budget is a great place to begin (checkout Adam Lisowsky’s 3-Minute Advisor series on our Youtube channel if you need some help).
Perhaps the most helpful piece of advice that I can give you is to pay yourself first. Warren Buffet once said, “Do not save what is left after spending; instead, spend what is left after saving.” I understand how hard it can be to say no to a Starbucks, but small sacrifices add up.
As we embark on this clarifying journey together, I encourage you to submit any ideas, topics, or questions to firstname.lastname@example.org. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. “Let Me Clarify” is a weekly blog containing Chad Baxter’s insights and thoughts about a variety of topics. To learn more about Chad, click here
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