If there’s anything we should have learned from The Great Recession, it’s the importance of having a sufficient emergency fund.
Also referred to as a rainy-day fund, a cash safety net, or a cash buffer, an emergency fund is crucial in protecting our assets from any of life’s unexpected events such a loss of a job, a medical emergency, or any other worst-case scenario.. like a prolonged recession.
There’s nothing worse than having to tap your retirement savings, sell your mutual funds, stocks, bonds or other assets at a loss, or to have to borrow money (if you can) when you’re out of a job, all because you didn’t have a ready amount of cash on hand in preparation for such a crisis.
Just think how bad things would be if you also carried a lot of debt, lost your job, and couldn’t pay your bills for six months or more. It’s a slippery slope that I wouldn’t wish on anyone. Well, almost anyone, except for maybe a few corporate CEOs, Wall St. investment bankers, and corrupt politicians.
Personally, I’ve had to use my emergency fund a couple of times over the past years and I can’t tell you how important it was in helping me get through some transitional times. It really saved my ass.
Conventional wisdom states that one should have an emergency fund large enough to cover 3-6 months worth of living expenses.
While saving something is better than nothing, in my experiences I’ve found that 3-6 months worth of living expenses is less than adequate, and that an emergency fund with 6-12 months worth of living expenses provides a safer alternative. For some reason, living expenses seem to grow during a crisis and having that larger buffer really helps ease any anxieties.
So, before you begin to invest your savings into the stock market, make sure that you already have an emergency fund in place. But don’t just take my word for it. Listen to what our friends at The Vanguard Group have to say about being prepared for the unexpected.
Comments 8
Nice video
Posted 11 Dec 2009 at 1:28 pm ¶Some old school advice from Dennis Jacobe, Ph.D., Gallup’s chief economist:
My advice is that Americans should go back to some of the old financial principles as they pursue both their personal and business lives.
Consumers need to build a fortress balance sheet. Individuals should do everything they can to make sure they’ve got a manageable debt load. They should build up an emergency fund — savings that can last them from three to six months in case something happens to the employment in their household or if something else unexpected occurs. If they buy a home, they should buy it with a significant down payment and a reasonable relationship between their monthly payments and their household income.
If your company or organization makes investments, make sure you need them and can pay for them. You want to have a strong enough balance sheet that if economic forces outside of your company’s control have a negative effect, your business can handle things financially and continue to survive. Maybe just make a new year’s resolution that you’ll end 2010 with less debt and more savings than you did in 2009.
Sounds like simple common sense to me. How did we ever digress from these principles in the first place?
Posted 11 Dec 2009 at 3:54 pm ¶I had 2 years of expenses in cash, but decided (while the dollar was falling daily) that was excessive. I’ve since brought it down to 1 year and invested most of the cash.
Posted 12 Dec 2009 at 2:29 pm ¶Wow, two years worth of living expenses. That’s quite a savings accomplishment. We need more role models like you providing examples to others who say they can’t save that much.
You know your own situation better than anyone else, so paring down to one year of living expenses in your emergency fund probably was a smart thing to do.
Mercedes sister, Christine Benz, discusses better uses of extra cash when the dollar’s falling and yields aren’t keeping up with inflation. She does a good job of explaining what I mean to others who may be wondering why you took money out of your emergency fund.
BTW, for those just getting started, it’s always a good idea to view an emergency fund as a tool, more than an investment.
It should be kept in the lowest risk vehicle possible, such as a savings account, CD, money-market fund, savings bond, treasury note, or similar. Preservation of value, liquidity, and ease of access trump keeping it in more risky income and growth vehicles such as stocks and corporate bonds that could potentially lose value.
Posted 13 Dec 2009 at 4:38 am ¶What do I mean by slippery slope? Here’s an unfortunate example.
Posted 13 Dec 2009 at 6:15 am ¶I really think how much u keep as an EF depends on what kind of mental state u want to have during those difficult times. If you have 2 yrs of living expenses save up, you will not be stress because you suddenly have an urge for a cup of starbucks coffee..or think whether u can afford a newspaper or not.
In this recession, not even 1 yr of EF will be enough for most people.
Posted 12 Jan 2010 at 12:58 pm ¶You’re a man after my own heart John.
Posted 12 Jan 2010 at 8:51 pm ¶I agree completely with the wisdom of a higher emergency fund level. Far too often people get into huge financial trouble that would have been avoided if they had built up a solid emergency fund. Remember if you lose your job, the need to purchase health insurance may well increase your current monthly expenses.
Posted 23 Jan 2010 at 6:47 am ¶Post a Comment