I had a sizzling hot date with the Federal Reserve’s “Report on the Economic Well-Being of U.S. Households” report the other night and things got a little out of control – for ‘mericans, that is.
Just when you think that writing about basic stuff is, well, too basic – you come across face-to-palm research like this:
When asked if they have set aside an emergency or rainy day fund that would cover three months of expenses, only 45 percent of respondents indicate that they do.
Yeah, not having an emergency savings fund that can give you a few months buffer is bad because of the consequences it brings. But what comes next is worse. When asked how they would cover a $400 emergency expense,
47 percent indicate that such an expense would be more challenging to handle (than paying with cash or credit card in full at end of the month). Specifically, respondents indicate that they simply could not cover the expense (14 percent); would sell something (10 percent); or would rely on one or more means of borrowing to pay for at least part of the expense, including paying with a credit card that they pay off over time (18 percent), borrowing from friends or family (13 percent), or using a payday loan (2 percent).
That’s worth repeating: 47% of Americans could not cover a $400 emergency expense. So, it appears there is a big drop off between those who have a 3+ month emergency savings fund, and those who have nothing at all saved. This sobering news recently came to mind when confronted with a $2,200 emergency pet expense for a diabetic dog.
$400 is really not that much in the grand scheme of things, at any income level. To not be able to cover it is the equivalent of having zero savings or being in debt. And without any savings, the result is more (and the two most expensive kind of) debt – credit cards and payday loans, bumming off of family and friends (who could be similarly in trouble), or selling pets lying around the house. That is some seriously stressful and troubling stuff!
Unfortunately, emergencies (aka “shit”) happens.
“Twenty-four percent of respondents indicate that either they, or their family living with them, experienced some form of financial hardship in the previous year.”
And here’s what the breakdown of those hardships look like:
This is personal finance 101. Actually, it’s not even that. It’s “the school of life” 101. And the first time you have an unexpected expense that you cannot cover, you are taught that lesson. There should be no need for do-overs for it to sink in.
I understand that some folks don’t have any savings and don’t mean to trivialize financial hardship, but anyone in this country capable of getting a job should be able to build up at least a tiny emergency savings fund to get themselves out of this downward spiral danger zone. That last thing anyone should want in the event of an emergency is the stress of not being able to pay for it.
For someone in debt or with no savings, here are the steps to approach it:
- Build up a tiny buffer emergency savings that covers most unexpected emergencies: insurance deductibles, prescription drugs, a lost job, etc. Start with $1,500 and build from there. The goal here is to avoid taking out ridiculously high debt or doing something that puts you in an even deeper hole. Sell your hair, your plasma, your junk (pets excluded) around the house to get there – and fast! Act as though your hair is on fire – this is nothing to be passive about or put off for another time.
- Attack that debt with a vengeance. Start with the highest interest debt and work your way down.
- Once you’ve defeated the high-interest debt (5%+), then continue to boost that emergency savings to 6-12+ months.
- After you’ve accumulated more than 12 months, your emergency savings can be passively invested with a discount broker to further grow, and replenished if it dips below the 12-month mark with market swings.
Basic? Yes. Easier said than done? Also, yes. But this is really important stuff that it appears about half of this country can hugely benefit from. Pass it along.
Those are great tips on how to attack debt and build an emergency fund.
I’m not too surprised about 47% of americans not having an emergency fund… I didn’t have one until I was 32 years old. I won’t make that mistake again.
That’s funny. I completely agree.. once you think you can be done writing about the basics…
When talking about investing your emergency fund, do you mean that you’re putting anything above 12 months into passively invested assets or that the entire emergency fund sit in a passive investment?
Not everyone is going to be comfortable with this, but in this interest rate environment, I think it makes sense to invest versus letting that cash sit there, earning no interest. 12 months is enough to cover a number of emergencies a few times over. And if you have enough cash flow to save that much, you can backfill if you dip below the 12-month mark.
This does require a credit card so that you can use that for the expense, and then get an ACH transfer or check to pay off the balance.
I totally know the importance of an emergency fund. Last year I was out of a job with no back up plan and no money.
12 months in cash for an emergency fund? Never heard anyone take that conservative of an approach.
12 months isn’t too long if a true emergency (the purpose of the funds) happens. The loss of a job can be offset with underemployment to slow the bleeding. A serious illness can lead to less income and then zero income once sick leave runs up. An elderly parent or child becoming ill can cost quite a bit upfront for treatment and care. The list goes on for major expenses that can happen and easily cost up to, if not over, a 12 month buffer. People still buy insurance even though the disasters they cover are unlikely to happen – similar scenario with an adequately funded emergency fund.
There is another way to build up the emergency fund. Pay more on the utility bills than the actual cost and have a running positive balance equal to a few months bills. Pay each months auto and mortgage payments three weeks after each other, over time getting a few months ahead. Pay insurance and other expenses that you know will happen months in advance.
Often, bad things come coupled together. An accident might also keep you from working for a while so you might consider your emergency planning as two separate funds, the fund to cover normal expenses when not working and a separate fund for extraordinary emergency expenses. The extraordinary emergency fund is not based on some number of months because people making less would need more months to equal the same size emergency fund.
This is a good psychological trick but it would be best to deliberately set money aside on a regular basis and not touch it. Something we should all learn how to do.
This could also not be accomplishing what you want, specifically on your mortgage. If you’re paying every 3 weeks instead of once/month, then it is possible all of that extra money is just going to principal and not counting as an additional payment. So even though you’ve made 9 payments in 6 months, the bank is still going to expect a payment in month 7… regardless of how much extra you’ve paid to principal.
(1) I don’t think one should be investing an emergency fund in any non-liquid asset. Your best bet is to put it in a simple online savings account that pays 0.8 – 1 % interest. Definitely not equities ( even passive funds ). The point of an emergency fund is to have funds readily available in liquid form when you need them. They should not be tied to an asset that may oscillate in value ( exactly what you should not be doing when you talk about an emergency fund ).
(2) 12 months of emergency funds is way too much ( as someone has already pointed out ). I would think 3-6 months is just about right.
Very sobering. Its posts like these that really hit the message home and I’m already thinking about beefing up my emergency fund. At the moment I have a 12 month buffer but it couldn’t heart to add a few more months of money to give you peace of mind. Insightful post, thanks for sharing.
12 months of income or expenses? A lot of people with higher incomes have discretionary spending that could easily be cut back, or simply don’t incur that many expenses in the first place.
If it is 12 months income, I don’t recommend keeping it in cash. Or, only keep it in cash if your portfolio/risk tolerance dictates it. (e.g. You have a $100k portfolio and deliberately keep 30% in cash – this could be your $30k emergency fund).
Assets fluctuate but not THAT much. A balanced portfolio won’t disappear overnight. If it does, we’re all in trouble.
For those at lower incomes, particularly if you spend most of your money – seriously consider saving up 3-6mos income in cash. You aren’t missing out on much by not investing. Reduce spending if you have to, to get there. Too many people are one paycheck away from ruin.
Paragraph 1. I wouldn’t limit yourself to an income level for being able to cut discretionary income. Plenty of people, at least in the U.S., spend a good portion of their income on non-essential items.
2. The post is directed at 12 months of expenses, since that’s what will be spent with the loss of an income.
3. Agreed. A properly diversified net worth is meant to sustain market changes and market shocks.
4. I’m not following this paragraph. The market is and has been doing well for roughly six years now (which historically means a correction is due to happen in the next few years…explanation for another time). Also, why should lower income people have a smaller emergency fund? If someone makes less, their necessary expenses (car payments, mortgage, etc.) should be lower than someone with a much higher income, but if 100% of income is lost, then the 12 months are equal for everyone, regardless of prior income levels.
I am generally pretty risk tolerant, but I would reconsider investing your entire emergency fund. Maybe six months invest, six months in a savings account? The entire point of an emergency fund is that you don’t know what is going to happen – that’s why it’s called an emergency fund and not your every day fund. Sometimes an actual emergency will require cash, not a credit card. Cold hard cash.
I think 98% of emergencies can be charged. But what happens when the emergency is more than your credit limit? When the emergency is in a foreign country where credit cards aren’t as popular as the US? When a natural disaster is approaching and cash is king for things like gas, water, supplies? Yes, I realize they’re all unlikely but if things that were unlikely never happened no one would have an emergency fund in the first place.
Stocks are not illiquid,as the funds invested are available any time. Perhaps you mean people should not put emergency savings in non-principal guaranteed assets. However, depending on your financial circumstances (tolerance for risk), that decision is a personal one.
G.E. once said invest the emergency funds in a short term bond fund.
Agree with everything except one point, which is a personal decision for everyone – what rate is “high interest debt”?
5% seems a bit low for me to immediately go after and wipe out. If I had a fixed rate at 5%, I’d throw some extra money at it, but most disposable income would be saved / invested. Can beat 5% now, and when rates start climbing back up, 5% debt will be even easier to pass on reducing ASAP.
Again, it all ties back to personal preferences and outlook. Reduce debt at the cost of illiquidity, or increase liquidity at the cost of 5%?
When I got my 1st real job, I decided up front to save at least 10% of it before I got used to spending it all. It’s nice to have money in reserve that I can tap anytime w/ no consequences.
It is always wise to have emergency funds. This would secure you when you down until you get back up again. It will also be an asset on how to start all over again with being buried in debt.
If someone is buried in debt (e.g. $20k) and spends their entire emergency fund (e.g. $12k) to offset the debt, what happens if a loss of income occurs before the remaining debt ($8k) is paid off? An emergency fund is an asset, but shouldn’t be used for anything other than emergencies. Otherwise, why even name it as your “emergency fund” if that’s not its purpose?
Considering emergency funds in strictly percentages and months is not a good way to do it, it is “one size fits all” thinking, while resulting in a different size for everyone without regard for what is needed. Someone making $40,000 a year is going to have a lot less saved than someone making $100,000 a year if the same formula is used. But if there is a medical emergency, the person making $100,000 a year might have gotten the more expensive insurance with the lower deductible and co-pay and actually need the smaller emergency fund. Looking at the chart of financial hardships, the medical emergency is the highest category.
On the other hand, although no job related category is the highest, the combined of all the job related is significantly higher. Yet the majority of this is not loss of all income, but only a partial loss. There is no clear cut one size fits all answer.
Over the years, I’ve talked to financial advisors about their general rules for emergency funds (Not the mass public and group advisors – but people who do individualized planning). They all said a few things in common:
1) Don’t think of emergency funds as a single fund. People have auto insurance separate from medical insurance separate from insurance on their home. For the emergency funds consider the total needs and keep the funds in multiple formats to match multiple problems of different types occurring at once. Often medical emergencies cause job loss emergencies.
2) Have appropriate levels of insurance.
3) Match your plans to what really happens in your life. One advisor told me about a man who’s wife complained that the man was a miser and would not spend enough money on her. The advisor suggested that if he had to spend more money on his wife, consider the difference between buying for vacations or for quality jewelery. In an emergency, he could not get back the vacation money spent but he could sell the jewelery.