I was having a talk with a client recently and the topic came up about how much should be set aside for emergency savings. And so, the question is, how much is enough?
How much should you have set aside for emergency savings that can be quickly accessed? Like many answers, the answer is it depends.
The general prevailing rule is that you should have three to six months of money set aside for emergencies in case you become unemployed suddenly or perhaps you’re injured or sick, whatever the cause might be.
However, as we recently saw over the last two years, when something unexpected at a national and even global level comes along, three to six months of savings might not be enough. In 2020 and 2021 many people found out that they were very underprepared in their financial planning. They had virtually no savings and were dependent upon others.
There's a statistic floating around that basically says that a significantly large number of people could not pay for a $400 emergency need from cash from their own bank account. That's a very scary statistic on the financial health of a large percentage of the population. Charging that to a credit card may be a short-term solution but that credit card still needs to be paid off plus interest.
But how much you need kind of depends on you and your lifestyle. What things could you scale back if you needed to?
Keep in mind there are wants and there are needs. You need food, shelter, clothing and transportation. You could go several months probably without buying new clothes in an emergency but not very long without food, transportation to get around, and most folks prefer to have a roof over their heads.
And while we prefer to eat healthier, it could mean dialing back on the filet mignon and caviar and settling for hamburger for a while. But that’s a decision you need to make and your decisions lead to how much you should plan to have set aside as emergency reserves.
Generally speaking, emergency reserves are intended to be more liquid and that’s a financial term that means you can access it quickly and without penalty. Typically, a savings type account or maybe CDs.
While the stock market has certainly had a downturn this year with many folks seeing lower balances in their accounts and the idea of having your money safe and sound in a savings account sounds comforting, this past year has also seen inflation in excess of 7%.
As investors know there is always the risk of a market downturn but often overlooked is the cost of inflation on cash reserves. Maybe one year of higher inflation is tolerable for the comfort of having quick access to cash, but what if you never need that emergency fund for years and years?
Its sitting there in cash so you can access it quickly which is good, but what if inflation doesn’t drop below 5% for the next several years? A loss of purchasing power is just as much of a loss as a market downturn and quite often it’s a permanent loss of purchasing power.
To be clear I am not saying take all your emergency reserves and rush out and buy investments with it, but rather talk to your financial advisor and tax advisor and perhaps there might be ways to mitigate some of the inflation risk and have a moderate market risk to at least try to keep pace with inflation or not far too far behind while still maintaining this reserve for emergencies.
Every family will have a different set of circumstances that they need to plan for, but the key take aways are intended to be get moving on an emergency reserve if you do not have one and consider the long-term cost of inflation on cash sitting in an account earning virtually no interest with inflation at a higher rate than it has been in a long time.
As always when you are ready to schedule a call here is a link to my calendar or email me at matt@vwshi.com or call me at 808-954-6402.