A financial setback can be devastating. But building an emergency fund – a cash reserve – can help protect you in the event of an unfortunate circumstance. An emergency fund is just what it sounds like, a cash reserve or readily available pool of funds you can leverage for urgent short-term needs, such as the loss of a job or an unexpected medical expense.
When you’re working within a budget, you may wonder how you start saving for this emergency fund or how much you should set aside. There’s also the question of where to keep it so you can access it easily if needed. Here’s how you can begin building your financial safety net.
There is no magic number for what you should save and set aside as your financial safety net. Everyone’s circumstances are different, so examine your expenses, income, job prospects, family situation and health to determine how much to put in your emergency fund. The starting point is to establish a budget and narrow down household expenses that need to be met each month. While financial professionals typically suggest three to six months of these living expenses in cash, you may not feel comfortable unless you sock away even more. Or you may decide to keep only two months of living expenses in cash, plus more in assets that can be liquidated quickly.
Consider if you have short-term and long-term disability insurance or any other protection that would help if you became incapacitated and were unable to work. If you lost your job, how easily could you get another in your industry with similar pay? If openings are rare, you may want more savings to account for a longer job search.
An emergency fund will help give you the confidence that in the event of a crisis, like unemployment or disability, you will be able to sustain yourself through recovery.
Once you determine your savings goal, it’s time to start saving. There are several ways to approach building your cash reserve:
While credit lines can be a secondary source of funds in a time of crisis, they should not be your first line of defense. Borrowed money must be paid back and often at high interest rates. To avoid getting into devastating debt, try to focus on building your emergency fund prudently instead of leaning on lines of credit.
Most people, without much thought, keep their savings in an FDIC-insured, low-interest savings account. But this is not the only option. Choices include high-yield savings accounts, money market deposit accounts and short-term CDs. These typically offer higher interest rates than savings accounts, with little risk. Don’t confuse a money market mutual fund with a money market deposit account. An investment in a money market fund can lose money and is not insured or guaranteed by the FDIC.
Some fixed-term investments, like a CD, may impose a significant penalty for an early withdrawal. If you’re planning on using these investment vehicles as part of your cash reserve, you should stagger their maturity dates over a short period of time, perhaps two to five months. This will ensure you can access funds quickly to meet any sudden financial needs.
Creating an emergency fund shouldn’t be a set-and-forget exercise. While the assets will remain untouched unless there’s a crisis, you should revisit your financial circumstances and account balance periodically to make sure you’ll have what you need, when you need it.
A review becomes especially important when your personal situation changes or you experience a major life event, like getting married, having a child, changing jobs, caring for a parent or going through a divorce. Since your cash reserve is the first line of protection against financial hardship, you’ll want to make sure it fits your current needs.
Building an emergency savings fund that can come to the rescue will alleviate some of the stress and anxiety that can come with an unexpected event. A financial safety net will provide a sense of confidence and stability, allowing you to focus on getting back on your feet.
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Every investor’s situation is unique and you should consider your investment objectives, risks, and costs before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. This is not a recommendation to buy or sell any individual security or any combination of securities. Contact your advisor regarding your particular situation before making any investment decision.
This material has been created by Raymond James for use by its financial advisors.
