New Rules for Emergency Fund SavingsSubmitted by HearthStone | Private Wealth Management on November 3rd, 2016
New Rules for Emergency Fund Savings
We are frequently asked, “How much money should I save in my ‘emergency’ fund?”
First off, let’s define what we mean by emergency fund. It’s your “just in case” savings account – in case you need money to pay for an unexpected major expense. For example, your water heater breaks, you need a major car repair, or have to pay for some expensive dental work. We’re not talking about emergencies such as fires, earthquakes, or power outages.
The old rule of thumb (embraced by many financial planners) was to keep six to twelve months' expenses in an emergency fund. This fund was defined by readily accessible cash, such as a checking or savings account. The rationale was simple: in case of a major unexpected expense, you would have immediate access to adequate cash.
Times have changed. There’s a new set of rules for saving for unexpected expenses. The current model is to keep as little cash as possible in checking or savings.
Why the change? First, we all know that the return on cash, checking and savings is zero, or very close to it. So, why have any more of your money in a non-productive state than absolutely necessary? You’re better off in the long run investing the money wisely.
Second, when is the last time you had a true unexpected major expense? For most of us, they come few and far between. And, we’re grateful for that.
Finally, there’s less of a temptation to spend the money if it’s invested and not sitting idle in your bank account. Out of sight, out of mind.
So, what should you do? We suggest keeping two to three months’ expenses in cash. If you know you’re going to have a large expenditure within the next year, such as a new car or major home repair, stash some money away for that, too. Then, invest the rest.
Keep a credit card or two on hand for emergencies. Look into setting up a home equity line of credit. Both of these forms of credit can be dangerous if misused or abused. So, don’t look at them as ready cash, but only to be used in case of a true emergency. If you happen to use a credit card as a “payment card,” make sure you pay off the entire balance each month. And, make sure you’re getting points of some sort for using it.
If there is an unexpected major expense, and we hope there never is, then you’ll have immediate access to funds through your credit. Plus, you’ll have a month or so to free up some cash from your investments to pay off the balance.
In the meantime, your money is working harder and helping you reach your long term goals.
Like any rule of thumb, this should not be considered personal advice. Talk with us about your situation. We’ll help guide you toward more informed decisions about emergency savings.