Here’s the Deal With Emergency Fund Savings
By: Nathan Zarcaro
Tags: Personal Finance, Emergency Fund, Money, Saving, Money Management

E verything to know about rainy day savings

Ah, the age old question. Read this article to get the answers to the following questions.

How big should your emergency fund be? Why is it important to save money for circumstances that may never happen? What do you do when faced with a financial emergency ? Where should you keep your rainy day savings?

What is an emergency fund?

Your emergency fund is a liquid savings account that you can use should you encounter unforeseen expenses in the future. These expenses can be small or large, but they are usually unexpected. Common examples include:

Job loss

Home or car maintenance

Medical issues

The common theme here, unfortunately, is the attempt to protect yourself from all of the negative events that life can throw your way. This is not money to spend on a vacation, house, or new car. It is money that you need to have ready at a moment’s notice.

I’ll be honest — it can be tempting. But think of this as the extra buffer that you never want to use. Nevertheless, it is a cushion that you need.

How much do you need in emergency savings?

What you’re about to read may seem like an overreaction, but I assure you it is not.

Grow Your Green formally advocates that you plan for the unexpected in the form of a twelve-month emergency fund, if at all possible. Constantly saving for a financial emergency during good times may help to ease the burden of whatever tomorrow has to offer.

If 2020 has shown us anything at all, it is that the unexpected can become reality overnight. And in the case of COVID-19, the unthinkable became reality overnight.

Now, the good news, at least for some of you. This twelve-month suggestion is negotiable depending on your monthly overhead and number of dependents. Start by walking yourself through the graphic below.

But in all instances, being able to cover at least three months worth of expenses, at a bare minimum, and ideally as close as possible to a year, can provide you the most valuable resource needed in a time of crisis: time.

Why is financial preparedness important?

The objective in preparing for an emergency is simple. You are trying to save as much money as you can in a liquid savings account. The faster you can reach it, the better. But even if it takes more time than you would like, remember that you never want to be in a position where you need to borrow money from others. Create a saving habit from it.

Again, and this bears repeating, but it is so important to constantly remind yourself of the following the next time that you want to dip into it for a luxury vacation or home renovation. These things are nice, but until you’ve secured your finances, it’s all about having enough money to cover your expenses.

Also, always remember that you are not just planning for a scenario in which you lose a job or need medical attention or your car dies. You are also planning for the scenario where everything goes wrong in short order.

It is common to think that this twelve month threshold may be overkill, that even if you were to lose your job, you will have unemployment benefits, food stamps, and other social safety nets to keep you afloat.

But what if you lose your job during an economic crisis and you experience delays in getting your benefits? As the 2020 coronavirus pandemic unfolded and millions of Americans found themselves unemployed in short order, people found themselves waiting for months for benefits.

In one instance, a man waited four months for unemployment assistance. A three-month emergency fund would have been exhausted, and not only would one not be able to cover emergency expenses, but he/she also would be completely at the mercy of the world in hoping that nothing else went wrong in the meantime.

A dead car battery, heating unit, or hot water tank only would have compounded this problem for an individual with no savings left.

Hope is never a strategy.

How to build up your rainy day fund

While the process itself may seem monotonous and boring at first, I trust that you see the need for a fund to finance your essentials. Follow these steps to boost your savings and determine how robust your savings cushion should be.

Determine what your monthly expenses are

Take a look at a few months worth of credit card statements and other transactions. Add together your rent/mortgage payment, any car payments with insurance/gas, average expected utilities, healthcare premiums, and food at a minimum. Make sure that you don’t miss anything obvious either.

Once you know what your monthly recurring expenses are, multiply that number by twelve. So if my monthly expenses are $2,500, I want an emergency fund of at least $15,000 (six months of expenses) and preferably closer to $30,000 (a full year’s worth of expenses).

How much should I save a month?

Keep in mind that an emergency fund large enough to cover a year’s worth of expenses may take well over a year to build — and that’s okay! If you are under the age of thirty or so, we suggest that you make your emergency fund the number one priority after taking care of your debt payments.

If you are over thirty but have a stable job and good health, you may want to consider splitting your priorities and investing at the same time . It is important that you don’t miss out on any additional years of compound interest.

For the time being, regularly contribute all you can to build up your rainy day savings as fast as possible, at least until you reach the three-six month mark. After that, while it is still important to reach twelve months, if your situation is stable, the urgency to save months seven through twelve is not quite as great as months one to six.

For some of us, we may be able to contribute $500 per pay period to meet this goal. For others of us, it may be $100. Either way, make sure your short term priorities align with your long-term goals. Allow yourself to save for a vacation or new car as a reward for hitting your emergency savings goals.

The first step to building a financially secure future is to prepare yourself from the opposite.

When you need emergency cash

Unfortunately, many of us will at one time or another need to access our emergency cash. But how do we know when this time comes and how do we begin to do this? Thankfully, the answers to these questions are simpler than we think.

As it pertains to determining when to liquidate money, always ask yourself the following questions.

1. Do I need money for something that I physically cannot survive without?

It may seem obvious, but yes, we do mean physical survival. Emergency funds should only ever be used to protect your life and keep your finances secure. This means things like rent, mortgage payments, utilities, food, and the like.

2. Is it something that I need to pay for right now?

Though rent is commonly due on the first of the month, for instance, many apartment associations actually do not consider you behind until a date a few days after that. Obviously make sure there are no implications to your credit, but there is nothing wrong with waiting until the last second to part with those valuable dollars.

Think about it this way. There is no real value or reward to paying something off early other than personal satisfaction. While you hopefully will not have to make any more hard decisions, it is important to maintain the maximum flexibility for as long as you can. Don’t part with money before you have to.

3. Can I justify this if I run out of money?

This is somber and difficult, but it’s an important part of the process. Try your best to live in the reality that you face at the time. Keep your receipts and review the expenses periodically. Imagine a scenario in which your emergency fund runs dry.

Make sure that you only use it for things that would not upset you later. Is buying fresh fruits and vegetables for your children going to lead to regrets? It will not. But is the same true for your craft beer, $6 Starbucks coffee, or hair appointment?

Perspective is important. You have to create a plan now as to how to pay for unexpected expenses when they arise.

Where to keep your emergency fund

Some people ask about using a ROTH IRA as an emergency fund, but I personally am against this idea. But I also don’t believe that there is one best account to save money in either.

Let’s explore the IRA idea anyway, though.

First, an IRA is by design a retirement account. Retirement accounts often have tax ramifications and/or penalties if funds are accessed before retirement. However, ROTH IRA’s do have one rule that could prove very useful in the event of an emergency.

Technically, you can withdraw the dollar value of your contributions at any point tax-free. This should be an absolute last resort, the last stand you take before you are homeless and hungry. Never take out sums that touch your earnings, or you will be penalized.

If you are going to go against convention, to try to double-dip and use a ROTH IRA to add to your stockpile in case you need emergency money, please do not invest this portion of money. Doing so could require you to sell investments at a loss, costing you more money and potentially penalties if you are forced to withdraw from your investments.

Follow the link to more specific ROTH IRA withdrawal rules.

Generally, I would encourage clients to pick a more traditional liquid savings account or brokerage type account, but there is more than one way to prepare for the unexpected.

Conclusions

Keep in mind the reasons why you are undertake this exercise each time you send money into your savings account.

The idea of having no savings left to cover your expenses, both expected and unexpected, should be enough to stoke fear in any of us. Preparing for a financial disaster is prudent, wise, and smart. Feeling unease about the future is as human an experience as there is.

Take these steps to safeguard your financial future and to find comfort in tomorrow’s unexpected developments.

What are your thoughts on emergency funds and how to best prepare for the unexpected?