An Often Overlooked and Undervalued Investment
Sunday, March 25th, 2012
When we introduce our children to the waves at the beach, there’s one important tool we require them to use in the rough waters: the floatation device. Yet as adults, we seldom practice what we preach and swim at our own risk – often more risk than is necessary.
The volatility of investing, the ups and downs of interest rates, and the ebbs and flows of the economy can feel like swimming in rough waters, particularly when periodic storms pop up from time to time. Do you have a financial floatation device?
Your financial flotation device is your emergency fund, but it is often overlooked by many. Simply put, an emergency fund is money you can get your hands on quickly when unexpected financial events occur. Why would we overlook such an important device?
The emergency fund is overlooked for three main reasons:
- We don’t think an emergency will happen to us.
- We have insurance for many of life’s emergencies.
- Idle lump sums of money can burn a hole in one’s pocket.
The problems are that everyone is vulnerable to an emergency, insurance has deductibles and may not pay for an entire loss, and lastly, we must separate the emotional connection between money and spending.
What constitutes an emergency? There are two key words to remember: sudden and unexpected. A new boat is not unexpected. Tires wearing out is not sudden. A new outfit is not unexpected (even though the event to which you’re invited may have been sudden).
True emergencies are loss of job or income, unexpected repairs such as sudden breakdown of vehicle or water heater, and deductible payments for medical insurance claims. Non-emergency events such as routine repairs, clothing, vehicles, boats, Christmas, and vacations should, ideally, be planned for separately.
Your emergency fund is your moat of protection against a sea of financial onslaught. Yet few have a moat any wider than a trickling stream. Why don’t we prepare for emergencies? Simply put, life is busy and expensive. There are bills to pay and children to send to college. Nevertheless, emergencies occur.
Follow these tips to build your emergency fund now:
- Strive for 3 to 6 months worth of expenses in quickly accessible funds.
- Don’t worry if you can’t fund the entire emergency fund immediately. Add a constant amount each month to build your fund even if it takes 5 years to get there. Any amount is better than none.
- Put your emergency fund in an account that is separate from your normal accounts. Although quick access is important, your emergency fund should not be viewed as a savings account for big ticket purchases.
- Should you build an emergency fund before paying off debt? It depends. If you will have your debt paid off quickly and your income is highly reliable, then you may be able to pay your debt first. If it will take years before your debt is paid off, then begin building your emergency fund now. A loss of income could prevent you from making your debt payments, but the emergency fund could pull you through.
- Do not worry about the low, or zero, return on your emergency funds. The objective of these funds is short-term in nature, thus short-term investments should be used.
- Resist all temptations to spend your emergency fund prematurely. Start a separate savings fund for spending, but preserve your emergency fund at all costs.
- Action step: Open an account this week with an initial deposit, even if it’s only ten bucks. Taking the first step will get you moving in the right direction. Make a commitment to yourself and your family to add to your emergency fund every month.
Disclosure: Bil Sadler, CFA, CPA, CFP®,Securities offered through H.D. Vest Investment ServicesSM, Member SIPC, Advisory services offered through H.D. Vest Advisory ServicesSM The views and opinions presented in this article are those of Bil Sadler and not of H.D. Vest Financial Services® or its subsidiaries.