Do You Need an Emergency Fund?
Having an emergency fund is the foundation for building and protecting wealth. Whether you have millions of dollars or are millions in debt, everyone needs an emergency fund.
Your Financial Foundation
If you have credit card debt (or other loans) and want to get out of it, you still need an emergency fund. Some of you may ask, “Why should we have an emergency fund when we should use every dollar to pay down debt?” The reason why you should still have an emergency fund is because you want to change the habit of relying on borrowed money to finance expenses that are a result of unexpected events.
No one is immune from the unexpected. There is a tendency to think that certain negative events will not happen to us because the chances are small. But you know, $#^% happens!
Have you ever gone to the emergency room and worried how much it is going to cost you? Having an emergency fund will help prevent you from using credit cards and paying ridiculous amounts of interest when the unexpected happens. As Benjamin Franklin would say, “An ounce of prevention is worth one pound of cure.”
How Much Do You Need in an Emergency Fund if You Have Debt?
If you are in debt, you don’t need a fully-funded emergency fund. You just need enough money set aside to provide a cushion so you don’t further increase the amounts you already owe. Depending on your situation, $1,000 should be enough while you pay down your balances. As necessary, adjust this amount as low as $500 if you have a small income or adjust this amount higher if certain events such as an upcoming job transition or medical procedure justify a higher cushion.
If You’re Debt-Free, How Much Do You Need in an Emergency Fund?
If you do not have debt or only have a mortgage, a good rule of thumb is setting aside three to six months of living expenses. If you have a job that is highly sensitive to the economy or if you are self-employed, I would recommend that you have at least six to twelve months of living expenses. But of course, if you think you need to pay for home repairs, a new car, or upcoming legal expenses, you should increase the size of your emergency fund beyond these general guidelines.
What if You’re a Millionaire?
You still need one because there will be times when your investments will be temporarily down in value. If an emergency happens and the markets are down, you’re potentially going to need to sell your investments at a significant loss. Having an adequately-sized emergency fund will protect you from the cardinal sin of investing: selling when everyone is panicking.
Should You Invest Your Emergency Fund?
You should not invest your emergency fund in something that could lose value. We need to keep this money some place safe and liquid. The goal is not to maximize interest or beat inflation. The goal of an emergency fund is to have it available when you really need it. For this portion of your money, the return of your principal is more important than the return on your principal.
Despite that, we still need to maximize the amount of interest we earn from our emergency fund. Traditional checking and savings accounts do not offer the best interest rates for safe money. I would recommend comparing what you can get from online savings accounts, CDs, money markets, I-bonds and short-term Treasury bills.
Do You Have Too Much Money in Your Emergency Fund?
If so, you can think of the amount beyond your emergency fund as your opportunity fund. Your opportunity fund doesn’t have to be all invested in higher return assets right away. Take your time to find investments that offer a good risk/reward proposition.
Need help finding good risk/reward opportunities? Please contact us.
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