When will your emergency happen? The fact is, no one knows when a medical emergency, household emergency, or loss of a job may occur. While we always advocate saving and investing as much as possible, it is important to have cash outside your investment portfolio for life’s unpleasant surprises. If these unfortunate surprises happen at the same time an investor’s portfolio is experiencing a decline, it can have a lasting effect on the investor’s portfolio and overall financial health.
This is why we advise having additional funds set aside in case of times of need. We typically suggest having 3 to 6 months of expenses set aside in an “emergency fund”. However, this is just a rule of thumb, and how much you set aside will depend on individual circumstances. Factors such as your overall financial situation, number of earners in the household and the stability of your career and income all come into play. For instance, if your overall financial assets far exceed your financial goals, you could aim to have just 3 months of expenses in your emergency fund as a hit to your investment portfolio would likely not derail your ability to meet your financial goals. However, if your income is volatile, perhaps based on sales commissions or your business’s success, you should probably aim to have more in your rainy-day fund (target 6 or even 12 months of expenses).
For younger clients who are just starting, putting away 3 to 6 months of expenses in extra cash can seem like a daunting task. As a starting point, aim for 2 months of mortgage or rent payments. Once you have that set aside, the next savings target you could aim for is holding enough in an emergency fund to cover deductibles on your various insurance policies. For instance, if your health insurance deductible is $5,500 you could target that as your next savings goal. Over time, as your earnings begin to grow, you can aim for that final destination of 3 to 6 months of expenses in your emergency fund.
Stay tuned for a follow-up post where we discuss different places to stash your “emergency fund” (spoiler alert: it’s not under your mattress). Who wants to sleep on a lumpy mattress anyway?
If you have any questions on how an emergency fund fits into your overall financial picture, please contact us here.