In our financial lives, one of the most basic planning tools is the trusty emergency fund—that cash sitting in the bank that helps you feel safe and secure each night. You know, that money you’ve been setting aside “just in case.”
You do have that fund, don’t you? Well, if you don’t, you’re not alone. If you do, you’re ahead of the game. Either way, here are some thoughts to encourage you to get started, or to bolster your conviction to keep saving.
Unexpected versus emergency
The term “emergency fund” can conjure up some vivid pictures. When the team members at my firm, Slate, Disharoon, Parrish and Associates LLC, discuss emergency funds with clients, things like “broken transmission in the car,” “the fridge died,” or “I’ve got to take advantage of that flat panel TV I saw on sale” come to mind. These are all good, but hardly constitute an emergency, and can reduce the level of conviction a person can have to actually set funds aside.
We prefer to call this account the “unexpected expenses account.” This can include all of those things, but we generally see people tapping these funds for things like an unexpected death in the family, an IRS audit, serious health problems in the immediate family, or a lawsuit.
How much is enough?
This is the question asked most often by our clients in regard to an unexpected expense fund. Our answer, while not always satisfying, is true—the amount is different for each person. There are rules of thumb such as three to six months, but in the real world, using rules of thumb in your financial life are generally not wise. Each person must take into account several things in order to come up with their number.
You need to ask questions such as:
• What are my professional risks? Some professions are exposed to greater risks than others. Keeping in mind elimination periods on disability insurance, limits on umbrella policies, malpractice insurance, and more, people should take the time to calculate their own potential risks.
• How long could my practice continue to generate revenue if my unexpected expense involved me not being able to work? An unexpected death in the family that requires an extended out-of-town trip could have you out of the office for several days. If you do not have partners who can step in to assist, revenue can quickly drop off and your receivables may not cover your absence.
• What is my personal situation? Do you have a special needs child? Do you have several children in school? Are the kids in college in another state? Are you part of a mixed family? All of these are contributing factors to the amount you need in your unexpected expense fund.
Finally, there is an emotional need for cash on hand. Some people think having a specific amount of money in the bank feels right, while others are more intellectual and think that having a specific number of months in the bank is best.
Getting the opinion of advisors such as your CPA, attorney, and financial advisor can help you dial in the amount you’ll want to set aside. Whether a person makes $50,000 or $1 million a year, the great equalizer is the need for cash for the unexpected. The bottom line is that any amount is better than zero.
