Why should save for an Emergency?

001 Why should save for an Emergency?

EMERGENCY = FUNDS!

Hello again everyone! Hello to everyone who is willing to make changes to his or her life and who want to control their own destiny. We are not selling religious views. We are not messiahs so please calm down. Despite the fact for many it is an actual religion… we are going to talk about Emergencies and why it is important to all of us to save funds for these unfair events in our lives.

SO WHAT IS AN EMERGENCY?

Literally speaking an emergency is always unexpected, most of the times serious and or dangerous situation which requires an immediate action on your part. Just think about what went wrong over the past year or two in your life or your close family members and or friends’ families. What appliance broke down? Did the basement get flooded? Did the garage door motor stop functioning? Did your car’s transmission die? Did the roof start leak? Did your daughter break her bone on a soccer field? Did any close relative had to be rushed to a hospital? Did anyone lose their job?

My intention is not to bring you down but start realizing that things go wrong all the time in all our lives. Things and people break, period! Machines and people are not designed to live forever. Machines and people need to be maintained to extend their lives and over time they are likely to be replaced.

Next thing to remember is that one something goes wrong it requires significant amount of funds to bring some normality to the situation.

YOU MAY ASK: HOW MUCH SHOULD I SAVE FOR EMERGENCIES?

Anything is better than nothing. Even $500-$1,000 saved can be useful towards small emergencies. But what about big emergencies such as loss of a job? Since one does not know what can go wrong it is better to be prepared for a big emergency. Ideally you should have access to funds that cover a few months of your family expenses. Basically you should look at what your monthly ‘needs’ are that include rent or mortgage, auto loan payments, credit card payments, various insurances, home maintenance, food and home supplies, utilities, clothes and other essentials.

You should make the list of expense items and amount for each by reviewing it with your family members. Let’s look at an example. If your after tax income after retirement savings is in the range of $3,000-$4,000 then having $9,000-$12,000 will cover you for about three months. $15,000-$18,000 will give you higher cushion and last for about five months. Your goal will be then to resolve the situation such as finding another job during 3-5 months.

Most of us do not have $9,000-$12,000 sitting around. So what to do? You have to start somewhere and come up with a disciplined plan to save money regularly either on a weekly or a monthly basis. You can save this money over a period of time. It doesn’t have to happen in just one year. You can achieve creation of this saving say over two-three years. That means you will need to save $3,000-$4,000 per year if you save the total required $9,000-$12,000 over three years. If you put away $240-$325 per month will create about $9,000-$12,000 in savings with 3% growth investment vehicle.

002 Why should save for an Emergency?

WHAT TYPE OF INVESTMENT VEHICLES YOU SHOULD USE TO BUILD EMERGENCY FUND ASSETS?

As emergencies happen you need funds immediately. That is why where you park money for emergencies should be liquid investment vehicles or in another words that can be sold immediately.

To make sure that you will be able to access the money when you need it, buy assets that have many buyers and sellers and that do not have any penalty for selling the assets for disposal. Savings account that pay a reasonable rate of return, stable value funds, short term treasury are some of the investment vehicles you can invest your emergency funds in to.

An important trick is to save these funds in an account that is not accessible to you easily. You should not save and hold these funds in the same bank account you use for all your daily cash inflows and outflows. Create a separate savings account (ideally a separate brokerage account) to save and hold these assets which grow over time. Only time you should touch these funds is when you run into a true emergency. That is why you need discipline to save regularly and discipline to touch the funds only in case of an emergency.

One more thing…

Let’s say you run into a minor emergency and had to replace a refrigerator which costed $2,000. Not to worry. You have the emergency fund you can use from the separate account. Over the next few months you will replenish the $2,000 as you will be in the habit of saving on a monthly basis.

Sunil Kulkarn

Sunil Kulkarn

Written by: Sunil Kulkarni, PhD, MBA, CFA
Founder, Nuts2Invest.com

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