Avoid using high-interest credit cards for emergencies.
Build an emergency fund covering 3-9 months of living expenses.
Supplement basic insurance to cover extreme financial risks.
Investing
Zoe Team and Kyle Attarian, MBA, CFA, CFP®, AIF® (Zoe Network Advisor)
6 min read
How much should I save in an emergency fund?
A good rule of thumb is to save between three to nine months of your essential living expenses in a liquid, stable account.
Why not just use credit cards during an emergency?
Credit cards often carry high interest rates (15-25%), which can create a long-term debt cycle instead of providing a prudent financial safety net.
Where is the best place to keep emergency savings?
An online savings account is recommended, as these often offer higher interest rates than traditional bank accounts while remaining liquid and accessible.
Undoubtedly, in the dynamics of life, you’ll deal with more than one curveball. This may show up as an unforeseen home or car repair, medical emergency, sudden loss of employment, or even the loss of a loved one. These events can stress various aspects of our lives, and our finances are no exception. While you can’t predict the future, there are a few steps we can take today to prepare ourselves for a potential financial emergency.
How many times were you asked as a child what you wanted to be when you grew up? If you’re like most of us, you probably lost sleep over the wish to become a firefighter or superstar. Regardless of your answer, your career probably looks different than you once imagined. No matter how much we dream or plan, life tends to prove our expectations wrong for better or worse.
Credit Can’t Cut It
If you’re like most Americans and have access to a credit card it may feel like a decent safety valve. However, utilizing something carrying a 15-25% penalty (aka interest rate) is far from prudent emergency financial assistance in the long-term, especially if you cannot satisfy the debt in the short-term. Compounding interest is not your friend on the credit side of the ledger.
The alternative takes time and focus: growing a nest egg to rely on when life gets out of equilibrium. It sounds daunting, which may explain why the majority of people don’t have one, but taking steps today to prepare for the unexpected can help you prevent borrowing from your future.
Do You Think Enough About Insurance?
An advantage point: Basic insurance has become such a staple in our lives that we often forget its power. For example, if you own a home or car, you likely carry insurance to protect your pocketbook from the cost of a significant repair or total loss. In addition, if you have health or medical insurance through the private market, an employer, or the government, then you are partially protected from the cost of most medical emergencies (depending on the breadth and quality of the insurance).
A sign that you should take a further step: Basic insurance may not be sufficient to stay solvent when it comes to some of the more dire emergencies that create a longer-term or even permanent financial crisis, death, or disability. This is especially the case for those with families that rely on their regular income to make ends meet and/or have debt hanging in the balance. Carefully planning for more extreme emergencies should be part of everyone’s financial planning process.
A stress test should be applied to the plan to measure the magnitude of financial shock these events might cause. While it may not be fun to think about, quantifying the impact of lost or reduced income from a disability or a permanent loss of income is crucial in the event of death. This analysis should incorporate your current coverage and help identify gaps that could be reasonably filled with supplemental insurance or increasing the existing range. Although there are many insurance solutions to fill these gaps, I highly recommend you discuss an insurance strategy with your Financial Advisor.
Building An Emergency Fund and Avoid the Temptations
In tandem with working through an insurance needs analysis, a prudent step is to work towards funding the aptly named emergency fund. This is fundamental to all financial plans and should be high on the priority list. A good rule of thumb is to target saving three to nine months’ worth of living expenses. Don’t fret if that seems unattainable at the outset. Emergency funds aren’t built overnight, nor do they have to be. Starting early and small is better than not starting at all, and you’ll be surprised what comfort you get from knowing you have this growing safety net in the works.
The emergency fund should be directed to a separate account to help avoid the temptation to dig into it unnecessarily. It’s also important to keep this cash and not be subject to market risk. Having liquidity and stability to depend on in a financial emergency is paramount. If we require emergency financial assistance, we need it to be easily accessible and have faith that it will be there when we need it most.
The best place to accumulate these emergency savings is in an online savings account, as they tend to pay higher interest rates than your traditional bank account. Even though the maximizing rate of return is not the primary objective, accumulating some level of interest may shorten the time horizon to fund the goal. It’s also better than earning nothing, which would be the case in a checking account. The current rising rate environment is also influencing savings account interest rates making them more attractive than they have been in over a decade.
When Should I Start?
The time to prepare for a financial emergency is now. Unfortunately, they often strike randomly, and we rarely get advanced notice. Vital to this preparation is having a well-rounded, holistic financial plan. Getting your financial house in order and identifying your resources and expenditures is essential to identify where you may be exposed.
Once this framework is built, you will be better equipped to design the safety net needed to minimize any financial disruption thrust upon us in times of crisis. Without a complete picture of where you are currently, planning for a financially stable, secure, and independent future is challenging.
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