One financial lesson I hope we have all learned from the pandemic is that every household needs to have an emergency fund in place. In fact, according to a recent survey, 29% of Americans were forced to tap their emergency funds during the pandemic, many to address medical costs.
Why You Need an Emergency Fund
Emergency funds are intended to pay for the unexpected, including the uninsured portion of medical bills (usually deductibles and coinsurance amounts), costs related to accidents, major house repairs and other similar costs. In this post, I will address why for certain households a larger emergency fund might be needed.
Reasons Why You Might Need a Larger Emergency Fund
In my blog posts and podcast episodes, I have suggested that most households should have at least six months of their household monthly cash outlays in their emergency fund, including debt service costs. There are circumstances, however, when this may not be sufficient to protect a household’s unexpected cash needs.
Here are some circumstances when you might need to have a larger emergency fund:
1. You find yourself using credit cards often for unexpected expenses. If you find yourself routinely reaching for your credit cards or using available bank credit lines because you face tons of unexpected expenses, you need may a bigger emergency fund. While it is important to make sure your cash budget considers all your normal expenses, your household may be going through a period when you are getting hit with the unexpected. Some people are more prone to financial emergencies than most. If you're one of them, you'll need to have a bigger pool of cash to draw from to cover them.
2. Your job situation is uncertain. Emergency funds aren't just intended to help you cover unexpected costs for repairs or surprise bills. They can also help you avoid catastrophic financial losses in the event you no longer have a paycheck. If you are in a profession or employed by a struggling company where keeping your job is uncertain, having more money on hand to hold you over for job loss makes sense. The more likely it is that you'll have to go without a paycheck for a while, the more imperative it is that you have a larger emergency fund.
3. It would take you a long time to find another job. In some lines of work, finding a new job can take a very long time. This may be the case if your skills are highly specialized (e.g., professional actor) or if there's a limited number of jobs in your area (you may have to relocate). If you find yourself in this situation, you should keep extra funds on hand.
4. Your family is dealing with serious medical issues. Unpaid medical bills (usually uncovered costs, deductibles and coinsurance amounts) are the most frequent reason given for personal bankruptcies in our country. Medical problems can leave you with massive bills and can also affect your ability to earn income. Having a larger emergency fund can help you to cover healthcare costs when you get sick and also ensure you can support yourself if you have to take time off while you recover.
5. You are a small business owner. If your primary source of income comes from a business where you are the owner and principal driver of the business, you should make sure you keep extra cash on hand to soften the blow of a business slowdown or to protect against a time when you cannot participate in the business due to illness or disability.
6. You're the sole breadwinner in your family. If you live in a two-income household, then the loss of one income may not be a catastrophe, because you'll still have money coming in. However, if you're the only one bringing in a paycheck, you experience a 100% loss in household income if you lose your job or need to stop working for medical reasons.
Where to Keep Your Emergency Fund
You need access and liquidity for your emergency funds. You need to be able to withdraw the money quickly, without penalty, if you need it. A great place to have access and liquidity for your emergency fund is by putting your money into one of the best online savings accounts where your money is FDIC insured. These accounts usually pay 4 to 8 times the rate of interest of brick-and-mortar banks.
Summary
You don't want to have a too much money in an emergency fund, because emergency savings won't generate very much earnings for you, given that they need to be easily accessible. We have all learned from the pandemic that unexpected events happen in our lives. To have the appropriate amount in your emergency fund, please carefully assess your household and employment situation. You may need more in your fund than you think.
Ready to improve the quality of your financial life? Harry is the host of a new podcast from the FinancialVerse where he shares practical ways to relieve money stress and anxiety. Each 7- to 10-minute episode is designed to fit into your busy lifestyle.
Subscribe today or ask Alexa or Siri to play the FinancialVerse.