How prepared are you for a financial emergency in your life?
Just think about it. What happens if your furnace would go out? Or you lose your job? Or your spouse needs an unexpected medical procedure?
Do you have money readily available to cover those costs? Or would you have to pull from your retirement accounts or put the bills on your credit card?
Americans aren’t prepared
Hopefully you fall into the former group and have an emergency fund in place to help pay for emergency money needs. Yet, according to a recent survey from Bankrate.com, 23% of Americans do not have any money to cover unexpected expenses. Another 22% only have enough to cover less than three months’ worth of expenses.
Even worse? People who pull from their retirement accounts to pay for life’s day-to-day surprises are only hurting their future selves. A study from the Center for Retirement Research at Boston College found that 401(k) “leakage” – which includes loans and hardship withdrawals – can reduce wealth in retirement by about 25%.
How much you should save
Bluntly speaking, an emergency fund is the financial foundation you should have in place before you do anything else with your money – including investing. This “padding” will help you better withstand life’s unknowns, protecting your finances – and even your retirement – from potential disaster.
At Simply Money Advisors, we recommend your emergency fund has enough money to cover at least three months’ worth of your most vital living expenses, such as your mortgage, your car payments, your utility and grocery bills, insurance.
But ideally, your emergency fund should cover six months of these expenses.
The added benefit
Having a properly-funded emergency fund also comes with an additional benefit besides giving you the flexibility to pay for unforeseen expenses; it can also help reduce your stress level. And, given that 59% of U.S. workers surveyed in the Global Benefits Attitudes Survey say they’re worried about the current state of their finances, this would probably be a welcomed change.
The simple fact of just knowing you’ll be able to weather a financial storm is a huge weight off of anyone’s shoulders. Your brain subconsciously realizes, “Hey, we’re going to be fine if a big bill pops up.”
This added sense of emotional security makes having an emergency fund even more critical.
Where to keep it
One of the questions we often get about emergency funds is, “But where do I put it?”
This is not an account that should be exposed to risk (i.e., being in the stock market) and it needs to be “liquid” (meaning easily accessible), so the answer is simple: a plain-old savings account or money market account is fine.
However, considering interest rates are still pretty low for savings accounts and money market accounts right now, you'll probably notice your emergency fund won’t earn a lot of interest… but that’s OK. The goal of this money isn’t to “grow,” so to speak.
It just needs to be there for you, whenever you need it, without penalty.
The Simply Money Point
Sure, an emergency fund is the least exciting kind of account you can have. It’s not flashy. It won’t make you a ton of money. It’s basically the Clark Kent of all your accounts: seemingly boring on the outside, but when the time comes, pretty handy to have around to save the day.
To learn more about getting on track for retirement, visit our Retirement Resources library for free educational materials.