The first half of 2022 has not been great. Inflation has hit a 40-year high, experts are predicting a recession, and buying a home doesn’t appear to be getting less expensive any time soon. Naturally, people are preparing for the worst, and many consider the country to be sitting on the precipice of a recession.
When preparing for potentially dire conditions, the topic of emergency funds and how much they should contain inevitably becomes a popular topic.
When discussing emergency funds, people tend to ask the same questions over and over. Experts and financial gurus subsequently give them the same solutions. Exceptionally broad questions such as “How much should I have in an emergency fund?” are asked incessantly, and nearly everyone parrots the monotonous “three to six months of expenses” response.
Six Months of Savings is Too Lofty a Goal for Most Starting Out
Financial literacy is a practical skill that requires near-daily discipline. But saving half a year’s expenses may be a colossal task for even the most disciplined individuals, if only for practical reasons.Suggesting that people should save six months of expenses in an emergency fund without considering most people’s financial situation is like telling them to buy a brand-new Tesla to combat rising gas prices. It doesn’t make sense, and it’s just lazy advice.
Take a Look at the Data
According to reports from the Federal Reserve, a staggering 36 percent of Americans don’t even have enough money to cover a $400 emergency. According to other data, 51 percent of Americans have $5,000 or less in their savings accounts. This becomes problematic when you consider that the average monthly expenses for Americans are $5,111. The numbers become far more alarming when the data suggests that savings accounts held specifically for emergencies only average around $2,000.The data suggests that most Americans simply are not in a place to put away even three months of expenses, much less six. Many of them cannot even afford a new set of tires.
The One-Day Fund
Putting several months of expenses away will take discipline, time, and potentially some changes in lifestyle and income. However, saving for a one-day expense is more attainable, and there is a higher likelihood that you will need these short-term emergency funds.I call this a one-day fund because of the type of expense that it covers. Think of the most money you have ever needed in a single day, whether for a blown-out tire or unexpected house maintenance. This is what the one-day fund covers. This amount is subjective and depends upon the individual.
When I worked as an advisor and asked my clients this question, answers would range from $200–$2,000, although most people usually placed this need at around $500. Everyone has had different experiences, so they will have different answers. The important part is that you configure in your head an amount that you’re comfortable with, and begin to allocate it.
The money in this fund should not be anywhere near your total monthly expenses, and around $500 seems fitting. As for past clients who said $2,000, I assume that in the past, they had some fairly dramatic circumstances or dangerous hobbies. Generally, having funds available for these types of emergencies will take care of most of the need for emergency funds. Unfortunate things happen, and it’s great to have funds available for the worst-case scenario, but there is a far greater likelihood that you will need money for a blown-out tire than that you will find yourself in need of six months of expenses out of the blue.
Month-by-Month Basis Afterward
Having money put away into a savings account for your one-day need will likely cover most situations that require an emergency fund. The next step would be to work your way up to an amount you are comfortable saving in your long-term emergency fund. Saving $5,000 is a notable feat for many people, even though it may only cover a month or so of expenses—and may actually require cutting excess subscriptions and making significant lifestyle changes. Much like discovering what your one-day fund should be, assessing how much you need in your emergency fund overall is unique to each person’s needs and comfort level. While it certainly may be six months’ worth, it does not need to be six months’ worth.Your Money Works For You
With inflation on the rise, keeping money in savings accounts is becoming less popular. While keeping money in a savings account for your one-day fund is fine, keeping larger amounts, up to several thousand, in a savings account may not be the most practical option. You will still want this money to be easily accessible, so liquidity is necessary. In order to retain liquidity—and perhaps earn a bit more as the money sits—other options include the following:- Money market accounts.
- Short-term bonds.
- Marketable securities.
- Shares of publicly held companies that actively trade on an established stock exchange.
Conclusion
Very rarely is there a “one size fits all” solution regarding financial advice. There is so much nuance when you compare people in similar financial situations. These disparities continue to grow as more people and situations are taken into account.If you have a stable job and have been there for a while, do you really see yourself being fired? Do you think it would take six months to find other work in the event you are terminated from your position? How did you fare during the pandemic? How did your company and industry do? When deciding how much you think you'll need for your emergency fund, these are all questions to ask.
If you really think you will only need three months’ worth of savings, imagine all of the more practical ways you could use that money, such as investing it in retirement accounts or in other assets.
It has been a tumultuous year for the markets, inflation is at an all-time high, and experts say a recession is inevitable. To be adequately prepared, you should have an emergency fund of some kind. Preparing for the worst, while hoping for the best, is always a sound strategy.
